Don’t Look Now — Government Is Borrowing At Rates Higher Than Some Home Buyers

Home loan rates are at decadal lows. If you were in the market for a home loan this festive season, you may have been able to borrow as low at 6.5% if your credit score was good.

If you did, count yourself lucky because even the Government of India is having to borrow at rates higher than that.

If you do an apples-to-apples comparison between a 30-year home loan (which is typically the maximum tenure), your starting rate currently would be 6.5-7.3%. The government is currently borrowing money for that period at 7.24%.

Ten-year money for the government, considered the benchmark rate for long term borrowings, is now coming at over 6.6%. Since a number of home loans are paid back within 8-10 years, a comparison between the prevailing home loan rates and the government’s 10-year borrowing cost also shows that some home buyers may be getting funds as cheap as the sovereign.

To be sure, since home loan rates are floating rate loans, the cost of this credit over the life cycle of the loan will vary. Yet, the prevailing rates are raising eyebrows. To understand why, a quick detour into first principles.

Borrowing by a sovereign, in its own local currency, is considered to be as close to risk-free as possible. While technically a government can default on debt in its own currency, such instances are rare. And so, the sovereign borrowing rate typically becomes a benchmark, priced differently across different tenures (known as the term premia). Over and above that, lenders build in a premium for the risk a company or an individual’s credit profile represents (known as credit risk premia), which determines the final borrowing rate.

Assuming that an enterprise or an individual is more likely to default than the government, logically, a loan to you and me should cost more than a loan to the government, across comparable tenors.

What has upset this balance in the markets?

First, demand and supply. The government has been a large borrower—for good reason—since the Covid-19 crisis hit. As revenue came under pressure and expenses soared, the government borrowed over Rs 12.8 lakh crore in FY21, Rs 12 lakh crore in FY22 and is set to borrow a similar amount next year.

That is a lot of government bonds to sell. Buyers of these bonds—banks, insurance companies, pension funds—have already bought a lot of these securities and demand is thinning.

Supply > Demand = Lower Price. Lower the price of the bond, higher the yield, which moves inversely. This has driven the spread between the overnight policy repo rate, at which banks borrow from the central bank, and the benchmark 10-year government bond yield to a record of over 250 basis points.

In short, the government is having to pay more interest to borrow for the long-term.

That doesn’t explain the current situation fully, though.

The deluge of liquidity in the system is another culprit for the skew in rates. The central bank flooded the system with liquidity after the Covid crisis hit, but loan demand is still modest, although it is rising. Deposit growth, in contrast, has remained strong.

Banks have, therefore, struggled to find avenues to park their liquidity and most have flocked to home loans. This, as BloombergQuint had reported earlier, is leading to some mispricing of risk. For lenders, home loans continue to offer a safe place to dock their liquidity. These loans, unlike many other categories of personal credit, are secured and have among the lowest default rates. So even if the lenders are making smaller margins here, they take comfort in the fact that defaults will be lower.

This has driven down home loan rates to multi-year lows.

It is unlikely that this skew in rates will continue for very long. So what will give? Will government borrowing rates fall or will home loan rates rise?

The latter seems more likely at present.

Three factors could push up home loan rates. First, if inflation rises, the central bank may raise its benchmark repo rate. Many economists expect that rates will rise starting April. Some, like Nomura, are building in nearly 100 basis points in rate hikes over the next year or so.

Home loan rates, which are now linked to an external benchmark – in most cases the repo rate, will rise if the repo rate rises.

Rates could rise even if demand for other credit, particularly from industries starts to rise and the liquidity surplus diminishes. In such a scenario, we could see a small uptick in new home loan rates.

Also, some banks have already started to raise their deposit rates. More will follow if the central bank nudges short-term borrowing rates higher and if government bond yields rise. All this would eventually lead to higher lending rates.

Is it possible that government bond yields will fall instead?

In the upcoming budget, the government will likely announce another large round of borrowings, which will keep government borrowing rates high. The central bank, which bought large quantities of government bonds last year, may also no longer be able to do so. But there is one scenario in which government bond yields may correct — an inclusion into global bond indices which could bring in another pool of demand, drive up prices and bring down yields.

For now though, the government may want to sulk about its borrowings costs even as home buyers smile about theirs. Enjoy it while it lasts, for it may not last long.

Ira Dugal is Executive Editor at BloombergQuint.