The market hates uncertainty. Unfortunately, 2009 promises a lot of it, starting with general elections expected in April-May. Today, the Interim Budget will provide some direction to the lives of bond dealers?it will give them an idea of the government?s borrowing plan for the new fiscal beginning April 1. Or will it?
A quick recap of fiscal 2008-09 that will end March 31, 2009: the government had, in February 2008, estimated borrowings of Rs 1,35,000 crore when it presented the Budget. In January 2009, after two supplementary demand for grants, its borrowing needs shot up by Rs 70,000 crore. The market guessed it, but was not certain. The suspense did not end here. Ten days back, the government realised it needed more and announced fresh borrowings of an additional Rs 46,000 crore. The market suspected this too, but again had to wait to be told. All this has eventually pushed the total borrowing for 2008-09 to Rs 2,51,000 crore, almost double the budget.
This has taken a huge toll on the yields?coupon rate divided by traded price?on government papers. The continuous easing of the monetary policy?cut in repo, reverse repo and cash reserve ratio?during the last four months had pushed down the yield of the most-traded 8.24% 2018 government bond to its all-time low of 4.86%. But then, fears of large borrowings pulled the yield back to 6.53% in February first week. It closed at 6.19% on February 13.
But hang on, the year is not over yet. Surprises may be in store for the current fiscal itself, leave alone the next!
The Interim Budget?except for giving an overall idea of government expenditure during the full year?is of little political significance. Finance Minister Pranab Mukherjee will take Parliament approval for government expenditure during April-June, by which time general elections will be over and a new government will be in place. This being so, the government will still present the Budget for the full fiscal in the backdrop of a slowing economy. The International Monetary Fund has forecast India will grow just 5% in calendar year 2009. And government managers have continuously emphasised the need for fresh doses of stimuli in the coming fiscal after having announced two packages in 2008-09.
Government borrowings in 2009-10 will be higher, if not at the same levels of 2008-09, given the consensus among political parties that public expenditure must be stepped up when the economy is powering down and private investments are not happening. Large borrowings will exert upward pressure on yields.
Inflation, on the other hand, is likely to continue its downward trend in the coming months, giving RBI more leeway to cut rates. This will push yields down.
Thus, RBIs assurance of managing government borrowings with least disruption will be put to full test. Going by what happened to yields in the recent past, RBI?s assurance is not convincing enough.
The design of the government debt manager?s open market operations leaves a lot to be desired. It has not quite resulted in a normal yield pattern, bereft of huge volatility.
Can the government and RBI make life more predictable for the bond markets given the available options to finance a huge deficit?
Though RBI has not said anything to this effect, market players expect the government to monetise a part of its debt. The expectation comes from the belief that large-scale borrowings will suck out liquidity from the system and crowd out private investments. Typically, this is achieved through a private placement of government debt with RBI. The central bank provides the required money to the government, effectively increasing liquidity and money supply in the system, without mopping up funds from the market.
There are two issues to take note here. One that poses a moral hazard is the stipulation of the Fiscal Responsibility and Budget Management Act that bars such private deals between the government and RBI. Though purists will scoff, this is not a huge issue, given that we are living in extraordinary times. But, more relevant is the liquidity position and the quantum of private sector demand for credit. If the system is awash with liquidity?as it is now?and private demand for credit is low, then monetisation is not really required. RBI can tap the market with little side effects. The problem arises when the system is short on liquidity and private demand picks up?which is expected to happen in India only in the second half of 2009-10. But then RBI can always spread out?both in terms of the time-frame and the quantum?the sale of such privately held securities.
What is most disturbing today is the volatility in the yield movement and the fact that the government and RBI are not clear about the borrowing requirement itself. At present, RBI times the market?it borrows when the yields are low and keeps waiting for them to drop to make the next move. Open market operations should be so conducted to arrive at a normal yield pattern. Once, volatility is taken care of, a straight policy of what the benchmark yield should be for purposes of borrowing, may be put in place. Right now, there seems to be little clarity on that.
pv.iyer@expressindia.com