Higher government borrowing unlikely to crowd out private sector

Higher government borrowing unlikely to crowd out private sector

The government’s dodgy budget arithmetic has bitten the bond markets. Yields on the 10-year government bond have soared to around 8.5%, the highest in three years after the Centre said it intended to borrow an extra 53,000 crore. That’s nearly one-third more than what it had budgeted for in February. Theoretically, a rise in bond yields will push up the cost of borrowings and crowd out the private sector, but that is unlikely to happen this time around.

Bond analysts say that the current spike in government bond yields represents a kind of supply premium. They expect the spread between government and corporate bond yields to come down. One reason for this is because banks are reluctant to raise rates. Credit growth is slowing as the accompanying piece shows. The incremental credit-deposit ratio since the beginning of this fiscal has fallen to 67.6% in mid-September from 83.8% in August. This trend of slowing credit demand is likely to continue as economic growth decelerates. In September, the HSBC Markit Purchasing Managers’ Index showed its slowest growth in nearly two-and-a-half years as order growth slowed and output eased.

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Secondly, from a credit supply point of view, there is not much of a liquidity problem in the banking system. Sure, banks are still borrowing 60,000-70,000 crore under the daily liquidity adjustment facility. However, analysts say that is also because of the excess sovereign bond holdings that banks have under the statutory liquidity ratio. There is no sign of stress in the interbank market, and both the three-month Mumbai interbank offered rate and overnight lending rates have remained relatively stable over the past month.

Besides, the present spike in sovereign bond yields itself may not last. Perhaps, yields may increase till November, which is the heaviest month in terms of government borrowing. But with the consensus opinion veering towards the end of the rate hike cycle, they may not rise further. “Given previous new bond auctions (where the 7.8% 2021 could not sustain lower yield levels), we believe it is unlikely that the market would assign much liquidity premium to the new benchmark," wrote Vivek Rajpal of Nomura Financial Advisory and Securities (India) Pvt. Ltd. “However, the new bond and perhaps the expectation of OMOs (open market operations) will likely cap yields. This assumes that Reserve Bank of India will hint at a change in stance on 25 October."