Indian Debt Market Braces For A Wave Of Public Sector Borrowings
Waves break on a beach in South Carolina (Photographer: Luke Sharrett/Bloomberg)

Indian Debt Market Braces For A Wave Of Public Sector Borrowings


The year 2020 will prove to be an important test for the Indian debt markets. It will also be a test of the Reserve Bank of India’s skills as a debt manager to the Government of India.

That governments—centre and states—will need to borrow more in 2020-21 has been clear right from the start of the Covid-19 crisis. In the last ten days, the quantum of that borrowing has also become clearer.

The central government’s gross borrowings are estimated to rise to Rs 12 lakh crore, 54 percent more than what was budgeted for in February. For states, the peak borrowing now permitted is Rs 10.68 lakh crore, an increase of 66 percent over the earlier permitted Rs 6.4 lakh crore. In the case of states, there is some ambiguity on the eventual borrowings since only an additional 0.5 percent of gross state domestic product is unconditional.

As such, the borrowings of the centre and states together will be somewhere between Rs 19.5 lakh crore to Rs 22.7 lakh crore.

Overall Public Sector Borrowing Requirements

Economists usually look at borrowings from the centre, states and public sector enterprises together and club them as ‘public sector borrowing requirements’ or PSBR. The extent of these borrowings tells us just how much of the available household financial savings are likely to get used up by the public sector and whether private borrowers would in turn be crowded out.

In FY20, the PSBR was in the range of 8-9 percent of GDP. Even at those levels, public sector borrowings were in excess of the net household financial savings of about 7 percent.

In FY21, this math will be skewed even further.

Computing borrowings as a percentage of GDP at this stage is a difficult task since there is no official estimate of what nominal GDP growth in FY21 will look like. But there are some estimates put out by private forecasters.

Kotak Institutional Equities estimated PSBR at 11.3 percent of GDP in a report dated April 3. Others believe it could be even wider at 13-14 percent of GDP since both the centre and states will see their deficits expand by 2 percentage points each.

Absorbing Higher PSBR

The question then is how well the debt market will absorb this surge in public sector borrowings, which will be well in excess of domestic household financial savings. Foreign portfolio inflows could have helped buttress increased borrowings but foreigner have remained net sellers of Indian debt between March and May. As such, banking on a large support from foreign buyers is probably not prudent.

So its broadly up to the domestic markets to absorb the increased borrowings. A number of factors will be relevant in determining how smoothly this borrowing goes through. The first of these is liquidity.

System liquidity continues to be in large surplus. Banks have been parking between Rs 7-8 lakh crore with the RBI via the reverse repo window. Neelkanth Mishra, India strategist at Credit Suisse explained this in a recent note. Currency in circulation is growing at a pace of 15 percent year-on-year, leading to M3 or broad money growth of 10.5 percent. “With nominal GDP growth slowing, excess M3 is at its highest since 2008,” said Mishra, adding that banks are parking all of the additional liquidity back with the RBI.

The hope will be that some of this liquidity will find its way at least into risk-free government issued debt. In this regard, the experience of the central government’s first expanded bond auction on Friday is noteworthy. The auction saw strong demand with a bid-to-cover ratio of over three-times. The rates at the auction also remained in check.

In fact, since the central government announced its increased borrowings, bond yields have remained range-bound after an initial spike. The central government’s 10-year bond continues to trade at a yield of around 6 percent. That’s still a wide ‘term premium’ to pay over the repo rate of 4.4 percent (and even wider if you see the reverse repo rate of 3.75 percent as the operative rate), but the premium hasn’t widened further despite the announcement of larger borrowings.

State governments have had it slightly tougher. But even in that market, after a shock first auction where rates surged, borrowing costs have eased. At the most recent state government bond auction, the 10-year state development loans were auctioned at a cut-off between 6.72-6.85 percent.

Sanguine About Central Bank Support

Apart from ample liquidity, another key factor in absorbing the increased borrowings will be the central bank’s support.

One reason why the debt markets have not reacted violently to the increased borrowings so far may be the staunch belief the RBI will step in when needed.

The central bank has not yet announced a calendar of open market operations, nor has it committed to any direct monetisation. Yet, there have been sporadic interventions via secondary market purchases even outside the announced OMOs and the occasional ‘operation twist’ which has helped the market hold on to hope of RBI support. RBI Governor Shaktikanta Das has also assured that the central bank stands ready to take conventional and unconventional measures as needed.

The actions and the words, together, have meant that the market for central government borrowings has remained largely orderly.

What about state borrowings? So far, the RBI has not conducted open market operations in state bonds. Some, such as former RBI deputy governor Rakesh Mohan, have suggested that it should consider this if state borrowing costs surge.

This step, however, may not be necessary immediately unless state government decide to front-load borrowings.

Impact On Private Borrowers

While surplus liquidity and central bank intervention may help support government borrowings, what about private borrowers?

A usual concern amid high government borrowings is the crowding-out of private borrowers. This year, the dynamics of private borrowings could work in one of two ways.

First, given the sharp slowdown in the economy, there may not be large corporate borrowing needs in the first half of the year. There will be emergency funding requirements due to loss of income, but most borrowers will prefer to tap banks for that kind of working capital as bank lending rates may be lower than market borrowing rates.

However, funding demand may rise in the second half of the year. Also, those who were borrowing overseas may need to come back to local markets due to tight overseas funding conditions. Also some segments, in particular non-bank lenders, who may exhaust bank funding lines may need to tap the debt markets.

For these private borrowers who do go to the debt market, higher borrowing costs may be inevitable. An increased supply of risk-free government paper and the rise in perceived risk across private businesses amid a slowing economy will mean there is little scope for a reduction in market borrowing costs for the private sector even if the central bank’s policy rates remain low.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.

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