Despite reasonably comfortable liquidity conditions, the long term bond yields have inched up significantly during the last few months. The yield on the benchmark 10-year bond surged by almost 100 basis points between April 17, 2009 and and September 10, 2009. The huge Government borrowing programme for the current fiscal to fund the mounting fiscal deficit has largely been responsible for the spike in the G-sec yields. The net market borrowing of the Central Government through issue of dated securities in FY10 is estimated to be Rs 3,97,957 crore, of which the Government has raised Rs 2,43,911 crore so far (up to September 4, 2009; including Rs 28,000 crore of MSS de-sequestering).
However, the fiscal year so far was marked by relatively low investment demand from the corporate sector owing to slowdown in consumption demand and excess capacity build up. This to a certain extent helped in limiting the adverse impact of the Government borrowing on G-sec yields.
Further, with inflationary pressures beginning to mount, the RBI is expected to reverse its accommodative monetary policy by the end of the current year, thereby dampening sentiments in the G-sec market. Inflationary tendencies are expected to build up again in the economy on account of high food-articles prices, a lower agricultural output and excess liquidity in the financial system. The heavy borrowing programme of the Government of India, coupled with the mounting inflationary pressures (which have the potential to propel interest rates upwards) might have made the investment in the long dated Government bonds seemingly unattractive.
The deficient monsoons and drought like condition in some States is expected to exert an upward pressure on an already high fiscal deficit, on account of the likely increase in expenditure on food subsidy and relief measures for distressed farmers. This too has impacted sentiment negatively in the bond market. However, the recent announcement of the Government to reduce non-plan expenditure on domestic and foreign travel, publications, advertising and purchase of vehicles of each Ministry/Department by 10 per cent is a positive development. This is likely to ease off some pressures on the Government resources.
While there have been significant upward pressures on the G-sec yield in the recent months, the RBI’s intervention in the G-sec market has helped in arresting the steep surge in G-sec yields. The RBI has been using tools such as synchronising the Market Stabilisation Scheme (MSS) buyback auctions and open market purchases with Government’s normal market borrowings and de-sequestering of MSS balances to maintain orderly conditions in the debt market.
Moreover, by managing the timing of the borrowing, the RBI and the Government have significantly limited the adverse impact of Government borrowing on private investment. In fact, the Government has borrowed around 61% of its net borrowing target for this fiscal so far (September 4, 2009), which might ensure availability of liquidity for the private sector in peak season that begins in the second half of the fiscal. The likely easing of the Government borrowing in the second half of the current fiscal might provide some respite to the surging bond yield.
Moreover, given that the bond market has already factored in most of the negatives such as the large Government bond supply, higher inflation expectations and expected reversal of the accommodative monetary policy by the RBI, it is unlikely to experience any steep increase in yields going forward. Nonetheless, the long term yields are expected to remain at the current elevated levels.
The author is Head-Economic Analysis, Dun & Bradstreet India
