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Bond market frets on fiscal path amid relief on FY21 borrowing

The question bond market is asking is whether the government would be able to bring down its market borrowing in the medium term

India’s central government has a poor history of bringing down its market borrowing. In absolute terms, the central government’s gross borrowing through dated bonds has come down only once in the last two decades. That was in FY19 when the government borrowed 5.9 trillion on a gross basis from the bond market, marginally down from 6.3 trillion borrowed in FY18.

The current financial year promises to be a brutal one for the government and the bond market. Gross borrowing this year is pegged at an unprecedented 12 trillion. On Wednesday, the government kept this borrowing figure unchanged against worries of extra borrowing for FY21.

But bond yields have at best slipped by 2-3 basis points on Thursday, a sign that the market is not entirely convinced. That is because the shape of the government’s finances do not give confidence to the market.

Loaded on debt
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Loaded on debt

Analysts at Nomura noted that the government faces a financing shortfall.

“Assuming the quarterly gross issuance of T-Bills is unchanged into fourth quarter of FY21, this would leave a financing shortfall of 3 trillion (1.5% of GDP) based on our projected financing requirement," they wrote in a note.

“Indeed, with the borrowing calendar ending by January 2021, there is still scope for some additional borrowing in February-March 2021; if auction sizes are maintained, they could raise an additional 1.08 trillion per month from G-Sec issuance," the analysts added.

For the bond market though, the going would only get tougher in the coming years. Investors are asking whether the government would be able to bring down its market borrowing in the medium-term.

“It is an important question for the bond market. The market would be patient for the next two years. But if the government is not able to reduce its borrowing in absolute terms, then this is going to emerge as a big worry for the market," said R. Sivakumar, head of fixed income at Axis Mutual Fund.

Hacking down a 12 trillion borrowing is a tall ask. The government borrows mainly to finance its fiscal deficit. But the level of redemptions of past bonds and short-term financing needs also plays a role. Also, a large part of the government’s revenue expenditure is fixed in nature. Ergo, the deficit gap to bridge would remain high and keep the borrowing level elevated.

This has implications for bond yields and bond traders now fear that yields may harden over the medium-term. That said, unless the supply of bonds is taken off from the market, bond investors would be loath to forgo compensation to absorb higher supply.

In other words, the demand for better pricing would lead to yields rising faster than the economy can afford.

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