The finance minister Arun Jaitley may think he has done a good job of reining in the fiscal deficit at 3.5% of GDP and may believe it’s time for the Reserve Bank of India (RBI) to now lower the repo rate. The RBI may or may not lower the repo but even if it does so, the cost of money is unlikely to come down meaningfully. That’s thanks to the big jump in borrowings from the corporate bond of Rs 60,000 crore—resulting from the higher capex outlays –Rs 5,02,500 crore, crore, up 18% over FY16—-by government entities such as NHAI.
If the money is mopped up, it will take the total borrowings to just short of Rs two lakh crore and could leave yields at elevated levels.
Already, the sharp increase in borrowings by the state governments of Rs 70,000 crore to Rs 3,10,000 crore in the current year have driven up yields: Rajasthan raised Rs 800 crore at a coupon of 8.65% coupon last month, Uttar Pradesh needed to cough up coupon of 8.83% while West Bengal forked out as much as 8.88%.
Yields in the corporate bond have been reasonably steady over the course of FY16; while in early October, following the 50 basis cut in the repo rate, yields fell by about 25-30 basis points, they have picked up slightly since then. That’s partly because the benchmark in October was around 7.56% level but moved up to levels of 7.85% and are now back at 7.65%. So, a PSU like REC mopped up ten-year money at 8.1–8.2%, indicating a spread of around 50 basis points over the sovereign.
The total borrowings from the corporate bond market in FY16 so far (April-January) have been Rs 3.7 lakh crore up about 5% over the corresponding period of FY15. PSUs have raised a smaller amount this year while private sector companeis have raised much more. Typically buyers of G-secs also buy bonds of NHAI and IRFC—probably the two biggest issuers. However, by one estimate, 60% of IRFC and NHAI bonds are picked up by HNIs and retail investors.
Typically individual investors prefer tax-free bonds as the returns are attractive especially for those in the 30% tax bracket. However, if the additional Rs 60,000 crore is to be mopped up, the government may not allocate a quota for tax-free bonds this year.
Much will depend on how large the corpuses of the the big investors in the corporate bond market insurers —Life Insurance Corporation and private sector firms—are. These players also invest in G-secs and given that the ternd in the collections of insurance premiums remains subdued the demand from insurers, at least is not expected to see any major pick-up in FY17. It’s not too different with mutual funds and companies. However, foreign portfolio investors (FPI) who have been big investors in Indian paper, given the relatively attractive returns—adjusting for hedging costs — could continue to invest helping keep yields on a leash.
Bank of America economists estimate the Reserve Bank of India (RBI) would likely need to step up open market operations (OMO) to Rs 1.75,000 crore in FY17 from about Rs 100,000 crore in FY16 to cover for repatriation of the maturity of FCNRB deposits of US$26bn in September.