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The projected economic rebound of FY22 will open up new avenues for lending and leave banks with little incentive to buy additional government securities, economists said, posing a challenge to the Reserve Bank of India’s (RBI’s) efforts to keep bond yields low to smoothen the government’s record borrowing plans.

Indian banks are mandated to hold at least 18% of their deposits in liquid assets including statutory liquidity ratio (SLR) bonds, making them captive buyers of government securities. However, they were holding as much as 25.7% of their deposits in SLR bonds already in March 2020, raising it further to 28.6% in December, as the pandemic and recession limited room for lending. However, as credit demand revives along with the economy, banks will find more profitable avenues for their money.

Sameer Narang, chief economist at state-run Bank of Baroda (BoB) said banks have been large buyers of government securities (G-Secs) in FY21 as credit demand plunged, purchasing G-Secs of about 7.5 trillion so far.

“Now, next year, if credit growth revives to some extent, banks will not have that kind of surplus liquidity to invest in government bonds. I would agree that to some extent, it will become challenging because this demand-supply situation has to now be managed for two years in a row," said Narang.

The yield on the benchmark 10-year government bond rose sharply after the Union Budget 2021-22 announced higher-than-expected borrowings. On 1 February, it closed 6 basis points (bps) higher at 6.06%. On Tuesday, it closed at 6.067%.

The government plans to borrow 12.1 trillion in FY22, only a bit lower than the revised estimates of 12.8 trillion in FY21.

The economy is expected to rebound in 2021-22, growing at 10.5% after contracting this fiscal, as the effects of the pandemic recede. The central bank recently cited improvement in energy demand, rural resilience and higher public spending to project an upcoming revival.

Experts peg credit growth to turn around as well, on the back of greater economic activity and demand for loans. Credit is expected to grow 8-10% in FY22, from around 5% in FY21.

“We are currently in a situation where despite excess liquidity, the market feels that rates should go up because the RBI is winding down and there is a high borrowing target in FY22," said Madan Sabnavis, chief economist, Care Ratings.

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