The core of the concern in the money market over the forthcoming Union budget is whether increased government borrowing will be self-defeating, because it could lead to a rise in interest rates.
That concern, however, seems to be abating, with the yield on the most traded benchmark five-year government paper falling to a three-week low on Monday. More and more analysts are veering around to the belief that the government borrowing number to be announced during the budget next Monday will be lower than initially anticipated.
For example, in a note by Edelweiss Research, analysts Rahul Chokshi and Varda Pandey say: “Market sentiment is expected to ease from current levels with the likelihood of confident buying as budget announcement wipes out ambiguities. With banks’ SLR (statutory liquidity ratio) investments near the historical low of around 26% of the net demand and time liabilities (adjusted for LAF), the largest treasury buyers are expected to shore up purchases to seek the 7% plus yields on dated government bonds.” LAF is the liquidity adjustment facility through which the Reserve Bank of India (RBI) manages liquidity in the short-term money market.
These analysts believe that cumulative borrowing for FY10 is likely to be lower than the amounts expected by the markets, thanks to the funds that will be raised through disinvestment and the third-generation (3G) licence auctions.
As HDFC Bank Ltd chief economist Abheek Barua points out, “While the interim budget entails net borrowings of Rs3,08,647 crore for FY10 and Rs83,283 crore for H2FY10, the market is factoring in an increase of close to Rs50,000 crore in these numbers. At Rs10,000 crore, our estimate of additional net borrowings is much smaller. This is likely to send the yield on the 6.05% 2019 paper lower to 6.25-6.3% from its current trading range of 6.9-7.0%.” Barua believes that the receipts from disinvestment and 3G auctions will enable the government to “increase planned expenditure by close to Rs30,000-40,000 crore without significantly impacting on the fiscal deficit”. In other words, the government will be able to have its cake and eat it too—increase spending without going in for too much additional borrowing.
Goldman Sachs economist Tushar Poddar holds similar views: “Although the deficit will be high, we think it can be easily financed, in part due to impending disinvestment and the auctioning of 3G licences. Long bonds may rally as a result.”
What’s more, bank lending rates may not necessarily follow the rates in the bond markets, because the spread between them had gone up earlier, when bond yields fell but banks were slow to cut their lending rates.
As seen from the recent 50 basis point cut in prime lending rates by State Bank of India, bond market concerns about higher government borrowing haven’t prevented banks from reducing lending rates. One basis points is one-hundredth of a percentage point.
At present, the excess liquidity with the banking system ensures that interest rates remain low. The pressures will start once bank credit growth starts picking up. Even at that time, RBI should be able to manage the liquidity through open market operations, while capital inflows are likely to be an additional source of liquidity.
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