The GSec market has always been an enigma, but with 10-year rates falling below 8%, the anomalies get curious. Government borrowing is at its highest and will probably be exceeded, RBI is not lowering rates and the liquidity gap is very highthe thumb rule to gauge liquidity is to see if incremental deposits during the year are higher or lower than the combined sum of credit and investments. There is a deficit today, leading to incessant borrowings through the repo window. In which case, why are GSec yields falling Only once in the past 5 years, in FY11, has the growth in credit exceeded the previous years growthat that time, GSec yields rose. In FY09 and FY12, however, yields rose even though credit growth slowed.
The answer is simple. First, RBI used the power of announcements to bring down GSec rates. An OMO operation for R8,000 crore was the first trigger, but this did not lead to a decline in rates. The second trigger was deferring a borrowing of R12,000 crore from January 4 to February 22this means, in effect a R20,000 crore of relief, equal to around a little more than a quarter percent cut in CRR. The announcement effects hence have played their role. The other interesting point is that with growth in credit being sluggish and banks being wary of creating NPAs by lending more money, it has made sense to invest in government paper. This has meant excess demand for such paper, thus pushing up prices and depressing yields.
This is where the conundrum lies, of high government borrowing not pushing up yieldswhen growth in credit is low, like it has been this year, due to the economic slowdown, not only can the government borrow more, it gets away with a lower cost as it becomes a safe harbour for banks. When demand for commercial credit picks up and banks are satisfied with the quality of assets, then the government has to be prepared to pay more for its borrowing, the true cost of funds as it were.