Mumbai: Bond yields spiked and the rupee weakened after the government said it will borrow an extra Rs89,000 crore from the market to fund a fiscal deficit projected at 6.8% of gross domestic product for fiscal 2010, taking the total government borrowing for the year to Rs4.51 trillion.
Higher government borrowing will crowd out private investments as banks will be left with little money after buying government bonds to lend to corporations.
Also, it will put pressure on interest rates.
Bond yields have been on the rise since February when finance minister Pranab Mukherjee announced a massive borrowing plan for 2009-10 during the interim Budget.
From 7% in the morning, the yield on the most-traded 11-year bond rose to 7.28% soon after the Budget announcement, and closed at 7.25%.
The yield and price of a bond move in opposite directions. According to dealers, the yield on the 11-year bond can rise as much as 7.6% soon.
The yield on 10-year paper, which is hardly traded now, had dropped to as low as 4.86% in January. On Monday, it closed at 7.03%, rising by 20 basis points. One basis point is one-hundredth of a percentage point.
The rupee fell 1.4%, its biggest one-day drop in three months, to close at 48.56/59 per dollar from its Friday’s level of 47.89/91.
“The bond market was surprised by the amount of extra borrowing. It was expecting between Rs40,000 crore and Rs60,000 crore (extra borrowing),” said B. Prasanna, managing director and chief executive officer of ICICI Securities Primary Dealership Ltd, a firm that buys and sells government bonds.
Arvind Sampath, director, rates trading, at Standard Chartered Bank, also said the bond yields factored in about Rs40,000 crore of extra borrowing. “A 25-basis point movement on a single day is a lot,” he said.
Bond dealers are eagerly waiting to see how the Reserve Bank of India (RBI), the government’s debt manager, manages the additional borrowing programme.
RBI had already transferred Rs28,000 crore worth of its intervention bonds, which is not a part of market borrowing but held in a separate cash account with the central bank, to the government directly. These bonds were issued under a market stabilization scheme (MSS) to suck out excess liquidity from the system created by RBI’s intervention in the bond market.
A large chunk of these bonds is to mature in June 2010. This means the government will have to float fresh bonds to redeem the MSS bonds.
RBI can also step up its repurchase of government bonds from the open market to help the government borrow more from the market.
It has been buying in the secondary market for quite some time now to ensure that dealers do not face any liquidity problem and the government is able to borrow extra at a cheaper rate.
RBI cannot buy government bonds directly, under the Fiscal Responsibility and Budgetary Management Act.
“RBI probably has no option but to increase the weekly auction size,” said R.V.S. Sridhar, head of treasury at Axis Bank Ltd.
In the past six weekly auctions, RBI has increased the borrowing size to Rs15,000 crore from Rs12,000 crore. Such extra borrowing could become a recurring feature for the remaining part of the year, dealers said.
According to dealers, buying interest in the secondary market will collapse as bond yields will continue to go up with every auction.
For now, the dealers are drawing comfort from the fact that there is abundant liquidity in the system. On Friday, banks parked at least Rs1.5 trillion of their excess funds with RBI.
Meanwhile, RBI on Monday evening said it will borrow Rs15,000 crore from the market on 10 July against Rs8,000 crore planned earlier.
The government will issue four bonds, including a new 10-year paper worth Rs6,000 crore, to mop up Rs15,000 crore.
“The government of India, considering its emerging requirements and the overall liquidity conditions, has decided, in consultation with the Reserve Bank of India, to auction dated securities amounting to Rs15,000 crore,” the central bank said in a statement.