The cost of borrowing for both central and state governments is set to rise in 2021-22 as the yields are gradually rising because of higher inflation expectations and also a much larger borrowing programme. The 10-year government securities paper, which is a benchmark, has shot up from a low of 5.94 per cent to 6.21 per cent in the last two months. The cost of borrowing for state governments is also rising. Let's study the major contributor to rising yields:
The inflationary pressure is continuing in the economy. The retail inflation or consumer price index (CPI) is currently at 5.03 per cent for the month of February. This is above the RBI's mandated 4 per cent (with a tolerance of +/- 2 per cent). The rise in the crude prices is actually contributing to inflationary pressure. The wholesale inflation index (WPI) has also doubled from 2.26 per cent in January to 4.17 per cent in February.
Global yields inching up
The infusion of liquidity post the global financial crisis hasn't resulted in any inflation, contrary to what many economists feared. But this time around the ultra loose monetary policy is expected to push up inflationary pressure. Take for example, the long-term yields in the US are inching up. The 10-year benchmark has already crossed 1.65 per cent. There are expectations of yields touching the 2 per cent mark by December. The rising yields are also putting pressure on the Indian equity markets as domestic investors are fearing return of dollar money, which pushed the markets up in the last one year, to safe heaven assets.
Higher government borrowings
The central government plans to borrow Rs 12 lakh crore, which is equal to what they raised during the pandemic year 2020-21. Similarly, states also have the leeway to raise additional borrowing. Together, the borrowings would be around Rs 20 lakh crore from the market. The five-year fiscal consolidation path of achieving a fiscal deficit of 4.5 per cent of GDP also hints at larger borrowings going ahead. Any shortfall in revenues and the need to invest in healthcare and capital expenditure post-COVID (second wave) will further push up fiscal deficit and borrowings.
Limited sources of raising resources
The bulk of the government securities are picked up by banks and insurance companies. The sources are limited and the banks also fear mark-to-market losses in case of a rise in interest rates tomorrow. While the RBI is trying its best to create a space for rising borrowings by creating surplus liquidity and allowing banks the benefit from held-to-maturity (HTM) for avoiding mark-to-market losses, the bankers are a bit cautious as they have limited capital to absorb any losses. The NPAs are also set to rise where they need higher provisioning from profits. The public sector banks (PSBs) as a pack is already making losses for three consecutive years. This is also one of the reasons why bankers are demanding higher yields.
RBI's exit from liquidity measures
The RBI is gradually moving towards stabilising the monetary policy as surplus liquidity for the last 18 months was directed at protecting the economy from slowdown and pandemic shocks. The liquidity through forex intervention is also expected to come down as foreign inflows have slowed down a bit due to rising concerns on inflation. The lower liquidity levels tomorrow will also contribute to pushing up the yields.