The Reserve Bank of India's (RBI) role as a debt manager for the government has come alive and will gain pace over the next one year. The task at hand is to climb the mountain of borrowing target, almost 54 per cent more than the budgeted target of Rs 12 lakh crore in 2020-21. The borrowing cost ideally should be 6 per cent at best or even lower if possible. A home loan borrower pays anywhere between 7.25 per cent and 9.50 per cent, while corporate sector ends up paying more than 11 -12 per cent per annum. But the only difference is the safe and secured government securities (g-sec) with guaranteed returns.
The sudden announcement of higher borrowing target by the government last week has already spiked g-sec yields by about 20 basis points to 6.16 per cent. Assuming there is no debt monetisation (printing of notes by RBI to fund government borrowings), the RBI will have the most challenging task at hand to manage the yields as higher supply of debt would depress the g-sec prices and shoot up the yields.
Higher borrowing cost for the government would upset the budget math for the government for a very long time. If the past experience is any indication, the RBI had managed the yield to its advantage by using its various monetary tools.
Take, for instance, the RBI had encountered a similar situation during the global financial crisis when the government borrowing shot up by over 80 per cent higher than what the government had budgeted for 2008-09. The next year was even worse with the government doubling the borrowings from Rs 2.73 lakh crore to Rs 4.50 lakh crore.
But the RBI did manage to keep the interest cost down by 50 to 60 basis points for the government despite a large borrowing programme. The RBI then followed a strategy of front-loading most of the borrowings in the first half, using market stabilisation bonds and relying more on short-term treasury bills.
The current situation is partly similar to the past experience. The government has increased the borrowing target by 54 per cent to Rs 12 lakh crore in 2020-21. And there is every possibility that more borrowings would be required this year or next year as the full impact of COVID-19 is not known yet.
The revenue collection has almost collapsed for both Centre and states. The businesses are almost shut with some, especially MSMEs unlikely to open operations even after the exit of lockdown. The government expenditure on healthcare, feeding the migrants and supporting the poor with direct income transfer is also going to increase until the situation normalises.
This time around, even banks have entered the crisis with a weak balance sheet. The banking sector, which is a major contributor to buying the government debt, is still grappling with high NPAs, lower profitability and reasonable capital levels.
Unlike 2008-09 when the economy was growing at over 8 per cent , the domestic economy is at the rock-bottom with few years of slowing growth ahead. The fiscal deficit and the borrowings will only increase.
The yield management in the current juncture will require work on multiple fronts. The RBI may have to cut the repo rate further to support the growth, which will help in lower yields in the g-sec market. Similarly, the government can create further liquidity by open market operations by buying securities from banks. In addition, the RBI could also do simultaneous buying and selling of g-sec, known as 'operation twist'. Under this, the RBI buys long tenor securities from the market and sells shorter tenor paper to manage the yields.
The RBI could also clear the room for banks to accommodate more securities. This can be done by hiking the held to maturity (HTM) bucket , which does not attract mark-to-market losses. Currently, the biggest fear for banks is expected jump in mark-to-market losses asincreased supply of government paper has the potential to depress the g-sec prices and increase the yield.
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