Faced with high subsidies and low tax revenues in the wake of a slowing economy, the government is likely to overshoot its fiscal deficit and borrowing targets for 2012-13 even after the diesel price hike, says Ashish Parthasarthy, head of treasury at HDFC Bank. In an interview with Aparna Iyer, Parthasarthy says it is certain the Reserve Bank of India may have to buy bonds through open market operations to support the borrowings during the October-March period. Excerpts:

There have been several comments from the government on fiscal consolidation. Do you expect a hike in the borrowing?

There is likely to be a hike in the borrowings. There is no way fiscal deficit can be at the Budget level. Even if diesel prices have been hiked, the deficit is likely to be higher than the target. Tax revenues are likely to be lower than budget target. Divestment has still not taken place. It is likely to happen, but it may take more time. Subsidies are higher and even with the diesel price hike, they will remain high. Market will not be surprised if there is an extra borrowing.

The banking system?s SLR is at 31% despite the cut. Isn?t slow credit growth and banks? bond buying enough to support borrowing?

SLR is already 31%, so from an overhang perspective, it is not good for borrowings. If credit growth picks up, than that could be an issue. Credit growth is unlikely to improve significantly though. Even so, the borrowing will require some support from RBI. I don?t think the market alone can absorb it.

Why is there a huge optimism over OMOs despite good liquidity?

RBI has said that it will use OMOs to manage liquidity. Liquidity can be viewed from different perspectives: One is of course from LAF number. The other is reserve money and money supply, and these are much lower than desirable. RBI is not creating money since foreign currency assets with RBI are falling. The only way to create money is by giving credit to the government, which it is doing via OMOs. So that is very likely to continue. OMO is needed to ensure adequate money supply. Without OMOs, gilt yields could be at 9%, but monetary dynamics won?t allow this.

IIP has come in bad and shows slowdown. When and how many RBI rate cuts are you expecting?

Definitely, the slowdown is deeper and broad based. To my mind, the issue is with investment. Even if you create demand, will it be met by domestic supply or by imports? If you cut rates, you could end up impacting savings rate because savers won?t get adequate return. This will increase demand for physical assets and imports may increase. Rate cut should not be necessarily a given thing just because growth has come down. The supply conditions have to improve.

If RBI is reasonably sure that a rate cut would spur investment, it will cut immediately. But if it leads to increased demand without increase in production capacity, the demand will get catered to by imports. This does not add to GDP but it will worsen the situation. I expect around 25-50 bps cut in policy rates this year.

Will the thread of stability that has come into rupee sustain? Where do you see it moving? Will RBI?s forward positions affect it in coming months?

It seems stability has returned. Right now, it seems to be in a band. There is depreciation pressure on rupee. But we could get inflows also. We have been getting them so far. RBI?s forward contracts are fairly spread across time and tenure. The forward rates won?t change on account of the maturing swaps, however, liquidity will get adversely affected. And that is why, we could possibly see OMOs. The case for OMOs is very strong. I see OMOs in November.