Although the bond markets have rallied after the Budget pencilled in a lower net borrowing number of Rs 425,000 crore and expectations the central bank will soon cut rates, hopes that interest rates will come down may be belied. That’s because while the government has sharply reined in expenditure to meet the deficit targets, the higher capex numbers — Rs 5,02,500 crore, up 18% over FY16 — are predicated on much larger borrowings by government entities such as NHAI and Nabard.
While the internal and extra-budgetary resources of these organisations is projected to rise from Rs 3.2 lakh crore in FY16 to around Rs 4 lakh crore in FY17, the funds to be raised from the corporate bond market will be higher by nearly Rs 60,000 crore at Rs 1.9 lakh crore. Indeed, in an unusual departure, the fiscal policy strategy statement of the Budget talks of funds to be raised by institutions like Nabard and NHAI and says “the government will bear the repayment/interest servicing obligations, except in the case of NHAI”.
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-point 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 AAA PSU like REC mopped up 10-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 companies 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.
Individual investors normally 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 trend in the collections of insurance premiums remains subdued, 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 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 would likely need to step up open market operations to Rs 1,75,000 crore in FY17 from about Rs 1,00,000 crore in FY16 to cover for repatriation of the maturity of FCNRB deposits of $26 billion in September.