Bond market has a godfather in RBI again as govt’s borrowing plan readies
Bond purchases under OMOs was the tool RBI used for two years to keep the government borrowing from disrupting yields in the marketIn the past, the bond market has looked at the Centre’s market borrowing plan with suspicion
The Reserve Bank of India (RBI) seems to be back as the godfather to the bond market, this time invisibly.
On Monday, the government announced it would borrow ₹2.68 trillion from the bond market in the second half, in line with expectations. This means full-year gross borrowing remains unchanged at ₹7.1 trillion.
In the past, the bond market has looked at the Centre’s market borrowing plan with suspicion.
The reasons to suspect the government’s borrowing numbers are more this time around than in previous years. Just two weeks ago, the finance minister announced a big cut in corporate tax rate and said that the revenue forgone would be ₹1.45 trillion. The loss of future revenue would be felt even as growth in indirect tax collections have disappointed. Analysts have indicated that the fiscal deficit of the government would widen to 3.5-3.8% of gross domestic product from the budgeted 3.3%, owing to the revenue shortfall.
Surely if the deficit rises, the government will have to borrow more from the bond market. But this time, investors have taken the Centre on its word and the 10-year benchmark sovereign bond yield fell marginally on Tuesday. There is reason for this faith.
The government has got a one-time bonanza of ₹1.76 trillion from RBI through a surplus transfer and it may get an interim dividend transfer as well. In August, the central bank’s board had approved transferring the surplus in FY20. Abheek Barua, chief economist at HDFC Bank, estimates the interim dividend to be ₹28,000 crore. This windfall will go a long way in filling the enlarged hole of fiscal deficit. Otherwise, the government risks increasing its borrowing cost and by extension, making it costly for the private sector to borrow as well. After all, risk-free yield is the basis on which lenders add a credit risk premium in giving private companies loans.
This is the invisible hand of RBI that could make it easy for the government to avoid dumping extra bonds on investors. Bank of America Merrill Lynch analysts have gone a step ahead and suggested that RBI continue with its open market operations (OMOs) to take some load off the market and keep yields in check. “We thus suggest that a large part of this additional borrowing (by the Centre) can be absorbed through higher OMO purchases by the RBI, or using the additional dividend transferred by the RBI, or through drawing down the surplus balances the centre has with the RBI," the bank said in a note last week.
Bond purchases under OMOs was the tool RBI used for two years to keep the government borrowing from disrupting yields in the market. It absorbed nearly 70% of the government borrowing in FY19 by buying close to ₹3 trillion worth of bonds from the market during that year.
One way or the other, RBI has come to the aid of the bond market. In the past, it was to keep liquidity tightness from choking banks. This time, it has come indirectly and perhaps not entirely out of free will.
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