Issuance of another 10-Year Benchmark Paper – its Historical Perspective

The fiscal slippages (the excess of expenditure over income) have been rampant since the global financial crisis of 2008-09. This led to heavy borrowing by the Central Government through bond issuances. The actual borrowing rose from Rs. 1.88 lakh crore in FY-08 to Rs. 4.51 lakh crore in FY-10. In FY-12, the government revised the total borrowing to Rs. 4.7 lakh crore; thus, increasing the total borrowing by Rs. 52,872 against the earlier estimate of Rs. 4.17 lakh crore. The RBI achieves this herculean task of unprecedented borrowing through different bond issuances. In India, most of the policy followers, economists and analysts widely follow 10-Year Government Security as the benchmark for the interest rate movement. So, the government announces the 10-Year Benchmark Paper every year.

In H2FY12, the fiscal slippages due to poor tax collections, failed disinvestment targets (due to bleak market scenario), small savings mobilization and higher tax refunds have forced the government to go for additional borrowing which will lead to continuous bond supplies in the range of Rs. 13k-15k crore every week. This has put a lot of pressure on bond yields including on 10-Year Benchmark paper, 7.80% GS 2021. The 10-Year Benchmark paper yield rose unidirectional to touch as high as 8.99 per cent in this fiscal and there is a speculation that it may touch its high of 9.25 per cent achieved during the financial crisis of 2008-09.  Unless the RBI comes out with OMO and does not exceed its revised borrowing limit, the bond yields will remain under pressure.

Historical Issuances of 10-Year Paper

It is common tendency that the RBI maintains a borrowing limit of Rs. 65k crore to Rs. 70k crore per security. So, it makes a judicious mix of securities so as to fulfill its borrowing plan so that the average maturity of securities and the average yield remain reasonable. The increased borrowing in recent years has forced RBI to auction new papers including 10-Year Benchmark Paper every year. The table 1 shows the historical 10-Year Benchmark Papers.

The table shows that there have been instances when two 10-Year Benchmark Papers have been issued so as to fulfill its borrowing limit. In FY-03 and FY-09, there were two 10-Year papers issued i.e. 6.85% GS 2012 & 7.40% GS 2012 in 2002-03 and 6.05% GS 2019 & 6.90% GS 2019 in 2009-10 respectively. In FY-12 too, an additional 10-Year Benchmark paper (8.79% GS 2021) has been auctioned including the earlier auctioned paper, 7.80% GS 2021.

Need of new 10-Year Benchmark

The table 2 gives the current outstanding of G-Secs. We see that the outgoing 10-Year Benchmark Paper 7.80% GS 2021 has a total outstanding of Rs. 68,000 crore. Other actively traded and auctioned securities have reached its historical limit of Rs. 65k crore to Rs. 70k crore.

In H2FY2012, the government has to borrow Rs. 2.2 lakh crore through a judicious mix of different securities. Since the 10-Year Benchmark Paper broadly defines the market sentiment, the government aims to keep it actively traded and liquid. However, as the current outstanding limit has reached to Rs. 68,000 crore in the existing paper 7.80% GS 2021, the need for the new 10-Year Benchmark Paper has arisen. The new paper 8.79% GS 2021 would easily absorb the supply for the remaining auctions and can accommodate up to Rs. 65-70k crore. In near future, the market may also witness few other new securities as existing securities like 8.13% GS 2022, 8.26% GS 2027 and 8.07% GS 2017 have already reached its historical outstanding limit (beyond Rs. 69,000 crore). The performance of the new 10-Year Benchmark Paper would depend largely upon the various macroeconomic factors including inflation, fiscal slippages, additional borrowing and OMOs, if any.

Happy Investing!

Has Interest Rate peaked out?

We are in a very peculiar situation; equity market is down but gold prices are picking up. Inflation has not been budging down; the liquidity deficit along with the RBI’s ‘calibrated’ turned ‘aggressive’ monetary policies has been driving short term rates. While the Industrial production as measured by IIP nosedived drastically to 1.6 per cent for Dec 2010 from 18 per cent in Dec 2009 mainly due of high base effect and slowdown in industrial activity, the headline inflation cooled marginally to 8.23 per cent, higher than the street expectation of 8.1 per cent. This extreme slowdown in industrial growth may not prevent the central bank RBI to hike the policy rates for another time as the inflation remains stubbornly high.

What other indicators say?

·         10-year G-Sec Bond movement

The G-Sec 10-year yield, an indicator of long-term interest rate scenario in India has been trading below its July 2008 peak when the world markets had been reeling under the immense economic upheavals.  In July 2008, the yield on 10-year note went as high as 9.4 per cent. Due to various accommodative measures announced by RBI, the 10-year note touched to its low of 5.2-5.3 per cent. However, with improved market scenario and increased government borrowing which led to wide gap in fiscal deficit, the bond yield inched upwards to the level 8.23 per cent, but still below the July 2008 level.

·         Short Term rates at its 26-month peak

The interest rates on 3 Months and 12 Months Certificate of Deposits (CDs) – these are short term deposits raised by banks from fellow participants; unlike normal term deposits, these are traded in secondary market – have reached to its 26-month peak on tight liquidity in the system. The liquidity deficit since 3G and WIMAX auctions which led to outflows of over Rs. 1 lakh crore coupled with the government’s high cash balances with RBI and sluggish deposit-credit ratio have led banks tap this market. Short-term rates have continued their upward movement after the RBI started hiking policy rates. The 3M and 12M CD rates have crossed 10 per cent albeit below the level of 2008 economic crisis as given in the graph.

Which is bigger risk for India – Interest rate or inflation?

Many think-tanks say that inflation is a bigger risk in India because the economy becomes haywire because of it. However, this can be dealt with tighter monetary policies albeit in India, the structural and frictional issues are dominant factors in building up the inflation. To a large extent, the RBI has taken protective measures but few more hikes are imminent. The global commodity prices have also been roaring for which the US’s QE II should be blamed. This has affected the local domestic prices too to a large extent.

Moreover, the high fiscal deficit has been worsening. Though in the current financial year, the government has been successful in narrowing down the deficit, thanks to one-time big inflows from spectrum auctions. They might not be successful in future too.

What is expected in future?

The market participants expect massive government borrowing in the next fiscal year to be announced in the upcoming budget in last Feb to meet the increased expenditures which will lead to more bond supply. This will put upward pressure on yields. Also the liquidity deficit which will worsen further on account of advance tax outflows in the current quarter will take the short term rates high further. Moreover, banks have been issuing CDs aggressively to build their large balance sheet size, another reason to boost up the interest rates. Hence, an expected gradual rise in interest rates, given sticky inflation would add to hardening of bond yields.

- Happy Investing!

- Amar Ranu

Fiscal Deficits at sub-5.5 per cent vs Higher Borrowing – which one to stick with?

Too many cooks spoil the broth! Rightly said... Post the global financial crisis, many countries – developed and emerging economies went for expansionary monetary and fiscal policies to revive their slowing economy. In India too, the slowdown of economy forced the Central Bank, the RBI and Central Government to announce a series of monetary and fiscal policies which shook the Indian Government’s finances. Three major expenses like provision for Sixth Pay Commission, Loan Waiver and MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Program) and various other subsidies including policy rate cuts led to significant intensification of the India’s Fiscal Deficit.

These unplanned expenditures in terms of loose policies and subsidies have badly affected the fiscal deficits. For Fiscal Year 2010-11, the Central Government fiscal deficit and combined gross fiscal deficit have been pegged at 8.2 per cent. However, there is an apprehension that it can shoot up further. In FY 2009-10, the fiscal deficit was 6.8 per cent of GDP. For FY 2011-12, it has been projected to bring it down to 4.4 per cent.

So, what happens if the fiscal deficit shoots up?

It means that the government will borrow extra to finance their planned and unplanned expenditures. If the government borrows extra for its spending, the level of money supplies rises which may compel to print more money, thus, leading to a hike in inflation rate. 

Current Scenario

With the improvement in economic conditions, the RBI has rolled back many of its accommodative measures introduced in year starting from 2008-09 bringing the policy rates to pre-crisis level. The net borrowing of Rs. 3.81 lakh crore will be executed smoothly except at few occasions where it has been devolved to PDs. However, the 3G and WIMAX auctions which collected worth Rs. 75,000 crore created the liquidity fissures which became a daily headache for RBI. In many occasions, the RBI has reiterated its comfort in repo borrowing up to 1 per cent of Net Demand and Time Liabilities (NDTL). However, the borrowing has been in range of over 2 per cent of NDTL which prompted the RBI to cut the SLR to 24 per cent and also introduced bond repurchase worth Rs. 48,000 crore under OMOs in four tranches.

The tight liquidity scenario was contemplating that the government may go for cancellation of some of its regular weekly borrowing as it has some unspent revenues lying with them. However, the Finance Ministry found support after the Nominal GDP data was released which rose on high inflation and on account of new series in headline inflation as measured by WPI. The nominal GDP
which expanded 19.8 per cent in the first half of the fiscal year 2010-11 provides the room for additional borrowing if the growth rate is intact in the 2^nd fiscal and the budgeted borrowing would amount to 5 per cent of the GDP only. The nominal GDP figures have risen due to burgeoning high
inflation rates which have been in double for most part of years and a new inflation index i.e. 2004-05. 

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Since the fiscal numbers are calculated in current prices and if the government sticks to the number plan, it may have an additional room to borrow. The 5.5 per cent budgeted Fiscal Deficit of the GDP was thought of on account of assumption of 12.5 per cent growth in nominal GDP. However, it has grown at 19.8 per cent in the first half of the FY 2010-11; so the government may announce in reduction of Fiscal Deficit number at sub-5.5 per cent or may go for additional borrowing.

Given the tight liquidity scenario, it is unlikely that they will go for additional borrowing.  However, the quantum of OMOs done totaling Rs. 41,266 crore (in four tranches) may give a reason to borrow again beyond the budgeted specified limit if the liquidity improves in the financial system so as to finance its social schemes. After all, the election preparation is on!

Happy Reading!       - Amar Ranu