India Inc's borrowing costs shoot up as credit growth gains momentum

5-year govt bond yields have risen to over 50 bps since the Budget 2021 has been presented.

Borrowing costs of the Indian companies have shot up around 50 bps in the last one month as credit growth starts picking up with the financial year coming to a close.

According to bankers, the corporate bond yields for the 5-year paper of public sector undertakings is now trading at around 6 per cent mark, up about 50-60 bps from pre-budget levels, while for private sector companies, the yields are even higher by 35-50 bps. (100 bps = 1 percentage point).

The rise in cost of funds will make policy making for the Reserve Bank of India (RBI) more challenging with the government announcing a massive borrowing of Rs 12 trillion for the next fiscal year – to gain economic recovery and activity in the wake of the Covid-19 pandemic with private investment yet to revive.

Shaktikanta Das, Governor of the RBI, however, assured the bond market that the government’s borrowing programme will be completed in a ‘non-disruptive’ manner while emphasising on the ‘orderly evolution’ of the yield curve. India’s GDP is expected to contract 7.7 per cent per cent in the current financial year, however, policy makers expect a V-shaped recovery with the economic survey projecting 11 per cent growth for 2021-22.

“The corporate bond yields have also hardened in line with yields inching up in government securities. The market believes that the economy is reviving so there will be demand for money. Credit off take will start now,” said Ajay Manglunia, managing director & head, Institutional Fixed Income at JM Financial.

“In that perspective economic revival has been factored in. In the last one year there has been no demand and the central banks tried to boost economic growth by ensuring liquidity.  Now with recovery in sight and things coming back to normal, RBI will now withdraw those measures in a calibrated manner,” Manglunia said while explaining the reason behind rising interest rates.

As domestic rates hardened some of the companies that were planning to raise funds like Indian Railways Finance Corporation, (IRFC) cancelled their plans and are now seeking to raise funds from overseas markets. While interest rates are lower when funds are raised overseas, when hedging cost is added, the quantum of gains will need to be seen, market participants said.

The hardening of yields, which is making the cost of borrowing dearer, comes despite the Reserve Bank of India (RBI) assuring of ample liquidity in the market to help interest rates stay benign.

Though the central bank has been trying to address the recent surge in the yield of the 10-year benchmark bond, yields on the five year paper have hardened more. Corporate bond yield typically tracks the 5-year bond.

“The RBI’s initial approach may have been to focus more on anchoring the 10-year point which in turn may have served to anchor other points on the curve,” said Suyash Choudhary, head - Fixed Income, IDFC Asset Management Company Limited.

“However, this did not materialise in practice as over the last two months the spread of 10-year to 5-year bonds has compressed significantly. It can be argued that this phenomenon is detrimental to effective transmission since, from the standpoint of both monetary policy relevance as well as anchoring borrowing costs outside of just the government, the 5-year and surrounding points may be much more relevant than the 10-year bonds,” Choudhary told Business Standard.

The yield on the 5-year government bond has hardened 55 bps since the Union Budget was presented on February 1. For the 10-year government bond, yields hardened 33 bps. The Centre’s plan to borrow an additional Rs 80,000 crore in the current financial year to meet the 9.5 per cent fiscal deficit target had made bond prices head south.

With credit growth picking up, the cost of the money will be dearer. According to RBI data, year-on-year credit growth picked up to 6.6 per cent as on fortnight ended February 12 as compared to 5.7 per cent on November 6, 2020. Banks typically rush to meet their year end targets in March which push up credit demand as well as interest rates.