For all the monetary easing by the Reserve Bank of India via a steep 125 basis points cut in the repo rate since February last year and a dovish narrative, the bond markets continue to sulk. Benchmark yields have stayed stubbornly entrenched around the 6.6% mark for many months now, even though there’s talk of another rate cut.
Had it not been for the 3 lakh crore worth of bonds that the central bank promised it would buy, yields may have edged up further. Banks have clearly lost their appetite for gilts not merely because of mark-to-market losses but also because the supply has been seemingly endless, especially from the state governments.
With deposits hard to come by, they would rather cash in on the fairly good demand for credit, as they should. To be sure, the central bank’s bond purchases have helped banks get access to some liquidity, but it would be helpful if the supply of paper next year doesn’t overwhelm the markets.
This is particularly true for the states because the higher interest rates on these loans are bound to influence the coupon rates of G-secs.
The Case for Central Fiscal Consolidation
There’s little point in driving up borrowing costs; already, interest payments account for about a fourth of total expenses. The Centre has done extremely well to rein in the deficit and can be expected to continue on the path of fiscal consolidation in 2026-27.
In fact, despite a likely shortfall in tax collections this year, the targeted fiscal deficit of 4.4% should be met partly by non-tax receipts and some pruning of expenditure. While the government would, no doubt, be keen to step up capital expenditure, it may want to cut its coat according to the cloth as there is simply not enough money to spend more.
One is unsure how the volatility in global markets will play out and it would be prudent to stay fiscally disciplined even if it means forsaking bigger allocations to some schemes and programmes.
The state governments, many of whom are using some of their resources to fund freebies, must mend their ways since revenue collections are clearly moderating; an analysis by Care shows that the growth in aggregate revenue receipts of 22 states in the April-November period of FY26 slowed to 9.2% year-on-year versus 17.4% in the corresponding period of FY25.
The worsening debt profile of some states is reflected in the elevated spreads. The markets would appreciate some discipline. Right now they’re penciling in the Centre’s gross borrowings for 2026-27 at close to `16 lakh crore. If this is right, it would be about 8% more than the current year’s `14.8 lakh crore.
That’s manageable. In fact, the rise in net borrowings could be even smaller. The net borrowings of states are expected to rise by 19% this year and therefore, they must be more restrained next year.
Addressing Demand and Global Integration
Even as it addresses the supply of paper, the government must also work to boost demand. Sadly, diminishing returns due to a depreciating currency have prompted foreign portfolio investors (FPIs) to offload sovereign debt. Again, a place in the Bloomberg Global Aggregate Index would have brought in investments and helped ease the pressure.
The government might want to assess the reasons for the extended review period. The market needs many more buyers. Else elevated yields will leave the cost of money unaffordable.