The Reserve Bank of India’s top brass will discuss the government’s market borrowing programme for the year beginning April with the ministry of finance on Thursday. There is nothing unusual about this. Typically, such discussions take place at the end of every fiscal year and help the country’s central bank, the government’s investment banker, chalk out plans for raising money from the market and prepare the borrowing calendar.
RBI announces a calendar for the first six months of the year indicating the amount that the government will borrow from the market each month through auctions and the maturity of bonds that it will float. This exercise is repeated in the middle of the year for the second half. This helps commercial banks plan to meet the credit need of corporations and individual borrowers and maintain the yield curve of government bonds. If too many government bonds issues hit the market in quick succession, banks will be left with very little money to lend. Besides, bond yields will also rise.
This time around, every market participant is keenly waiting for this calendar as the Indian government is set to borrow at least Rs3.62 trillion from the market to bridge its widening fiscal deficit. This is the highest ever it has borrowed in any year. If one adds to this the borrowings of state governments, the overall market borrowing by the Centre and states in 2010 will be much more and the banking system will not be able to support such a massive debt raising programme.
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According to economic affairs secretary Ashok Chawla, the central bank may draw up a three-month calendar for the borrowing programme, instead of a half-yearly one. This is probably because the market cannot support such a huge debt raising plan and the government does not have any choice but to privately place part of the debt with RBI.
The Fiscal Responsibility and Budget Management Act does not allow RBI to do this unless both houses of Parliament declare a financial sector emergency on “grounds of national security or national calamity”. After the general election, a new government will be in place by June and will probably formally suspend the Act to enable the central bank ease the pressure on the market and print money.
Barring taking private placements, RBI has been doing every thing else possible to keep the yield on government bonds down. It has already converted a portion of its intervention bonds, floated under the so-called market stabilization scheme to absorb excess liquidity from the banking system. The excess liquidity was created as RBI was buying dollars from the market to check the runaway appreciation of the local currency. For every dollar it bought an equivalent amount of rupees flowed into the system.
It has also been buying bonds directly from the market, as well as through auctions. The government’s market borrowing schedule for this fiscal will be completed on Thursday with a Rs12,000 crore bond auction. This will peg the annual borrowing programme for fiscal 2009 at around Rs2.5 trillion against Rs1.45 trillion. Despite that RBI has been able to maintain the yield on 10-year benchmark paper at around 6.8% because of its aggressive intervention in the market. The yield on 10-year paper rose to 7.2% in mid-March but has come down subsequently because of RBI intervention.
The challenge before the Indian central bank is to manage a disproportionately high government borrowing programme in the next fiscal year beginning next week. One way of doing it, as some analysts have been suggesting, is to raise the level of banks’ investment in bonds. Indian banks are required to invest 24% of their deposits in government bonds. If this level is raised, they will be forced to buy more bonds. But this will be a retrograde step as after more than a decade last year RBI had brought down the level from 25% to help banks lend more to corporations and individuals. Anyway, banks’ current investment in government bonds is higher, at least 28% of their deposits.
One way of encouraging them to buy more bonds could be protecting them from booking losses on account of depreciation in bond value if their yields rise. Currently, investments of up to 25% of their deposits in government bonds are protected from booking such depreciation if the bonds are kept in “held to maturity” (HTM) portfolio. The other two portfolios of banks’ bond investment are “available for sale” and “held for trading”. If RBI gives banks freedom to treat entire bond portfolio as HTM then banks will not be required to book depreciation when the yields rise.
Another way of soothing the frayed nerves of the bond market could be announcing upfront RBI’s bond buying plan from the market along with the borrowing calendar. In the first three months, the government may borrow around Rs1.3 trillion or so from the market. As around Rs30,000 crore worth of bonds are likely to be redeemed between April and June, the net government borrowing programme will be around Rs1 trillion. If RBI announces a simultaneous Rs50,000 crore bond-buying programme, the burden on banks, insurance firms and primary dealers will be Rs50,000 crore. This will take the pressure off from the market and help prevent any dramatic rise in bond yields.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as a deputy managing editor of Mint. Comments are welcome at firstname.lastname@example.org