Union Budget 2022: Govt borrowing plan may prompt reverse repo hike

15-40 bps raise likely in MPC meeting next week, say market participants

The huge borrowing programme announced by the government in the Union Budget on Tuesday may prompt the Reserve Bank of India (RBI) to hike the reverse repo rate in the monetary policy meeting next week, market participants said.

The government announced a gross borrowing of Rs 14.1 trillion and net borrowing of Rs 11.6 trillion for the next financial year – way above the market’s expectations. This may force the central bank to go ahead with its policy normalisation plan. 

The RBI has already started normalising liquidity with the withdrawal of the government securities acquisition programme (G-SAP) and tightened short-term rates. The next step could be increasing the reverse repo rate (the rate at which the central bank borrows money from commercial banks), in a bid to normalise the policy corridor. The rate has remained unchanged at 3.35 per cent since May 2020.

“In the last one week, (bond) yields shot up drastically, first due to minutes of the US Federal Reserve and later due to the Budget speech, where the fiscal deficit was revised higher plus nothing was on the index inclusion,” said Rahul Singh, senior fund manager, LIC Mutual Fund. “So now, the RBI has to react. Most likely it will narrow the gap between the reverse repo and repo rate to start with,” Singh told Business Standard.

The policy corridor, or the gap between the reverse repo and repo rate, is 25 basis points (bps) during normal times. After the onset of the Covid-19 pandemic in March 2020, when nationwide lockdown halted economic activity, the corridor was widened by the central bank. One percentage point is equal to 100 bps.

“We expect the Monetary Policy Committee (MPC) to start policy rate normalisation soon, raising the repo rate by 75 bps between August and December 2022 to 4.75 per cent. Before that, we expect the corridor to be normalised to 25 bps by April MPC from 65 bps currently. We maintain our view of a 25 bps reverse repo rate hike at next week’s MPC meeting,” Anubhuti Sahay, head of economic research, South Asia, Standard Chartered Bank, said in a note.

Suyash Choudhary, head (fixed income), IDFC AMC, said the bond market went into the Budget with two expectations. First was a gross borrowing programme of Rs 12 trillion, and the second was some clarification on the path towards global bond index inclusion. “However, as it turned out, both expectations were dashed …there has been no mention of the bond index inclusion road map. In the post-Budget media interaction, finance ministry officials indicated that the negotiations/discussions on capital gains were still ongoing. However, this didn’t seem very imminent,” he said.

Following the Budget announcement, the yield on the 10-year government bond jumped 24 bps in two trading sessions, which ended at 6.92 per cent on Wednesday.

With the repo rate at 4 per cent, the spread between the policy rate and the 10-year paper is 292 bps – the highest in at least five years.

“There are two arguments here: If the repo rate is 4 per cent but the bond yields are much higher, one can argue whether the market is in sync with reality. The post-Budget yield movement is because of supply concern. However, even if we discount the movement, a sustained 300 bps gap between the policy rate and market rate may give the impression of a disconnection between the central bank and the market,” Soumyajit Niyogi, associate director, India Ratings and Research, said.

“Our unsolicited advice to RBI is to proceed with the first tranche of reverse repo hike in the February policy to send a signal of business as usual and to clear the decks for further rate action later in the calendar year,” ICICI Securities PD said in a report.

“We would only point out that just holding policy rates constant while both the short end and long end of the yield curve shift upwards due to uncertainty would amount to a pyrrhic victory,” the report said.

The central bank has maintained the status quo on the policy rates for the last eight policy review meetings. Consumer price index-based inflation – the yardstick for the RBI policy making  -- hit a five-month high of 5.59 per cent in December. The central bank has a target of 4 per cent CPI inflation, with a variation of 2 per cent on both sides. The central bank’s monetary policy committee (MPC) will announce its review on February 9.