A day after the government announced record market borrowings to boost demand, bankers anticipate rising interest rates in the next six months.
The overall consensus was that the days of softer interest rates were over, since the government would be forced to pack in a dramatic increase in borrowing in the next three months, pressing the Reserve Bank of India to buy more bonds from the market, crowding out borrowing by the private sector.
Typically, demand for bank credit surges in the second half of the fiscal year.
Finance Minister Pranab Mukherjee will address the Central Board of Directors of the Reserve Bank on July 11 and is expected to discuss the government's borrowing programme and other issues.
Most bankers are also pinning their hopes on a scheduled meeting between the finance ministry and the Reserve Bank of India on July 17 to finalise the revised borrowing calendar.
Bankers are also waiting anxiously for the first quarter monetary policy review scheduled for July 28, where the central bank is expected to announce its strategy to ensure that government borrowings would not affect corporate fund raising plans and interest rates.
The Budget document shows that the central government will borrow Rs 4,51,093 crore (Rs 4,510.93 billion) from the market in fiscal 2009-10, substantially higher than the Rs 3,62,000 crore (Rs 3,620 billion) planned earlier this year.
Finance Secretary Ashok Chawla said on Tuesday there was adequate liquidity in the market. He added that RBI would increase its subscription of government securities through open market operations (OMO), but declined to say how much the Centre wants the central bank to mop through this route.
"Both RBI and various bank chairmen have said there is no liquidity problem to support the government borrowing programme," he said.
In Mumbai, O P Bhatt, chairman of State Bank of India told reporters after a pre-policy meeting with Reserve Bank of India Governor D Subbarao that interest rates could rise in the next six months on likely robust credit growth in October-March.
There was a discussion on how to manage the borrowing in a phased manner so that there is no pressure on interest rates, Bhatt said, adding, "my own view is that the interest rate scenario is soft. For some industries or for some sectors, further softening may take place. But six months down the line, when credit growth picks up and all the borrowing takes place, the rate could stabilise or harden a little bit," Bhatt said.
Bond dealers have had a tough time ever since Finance Minister Pranab Mukherjee's announcement of a higher fiscal deficit of 6.8 per per cent against 5.5 per cent stated in the interim Budget in February. The yield on the government bonds across maturities shot up by over 20 basis points on Monday.
What also added to the woes were signals that the government would front-load the borrowing programme as RBI announced auction of bonds worth Rs 15,000 crore (Rs 150 billion) last evening, against the weekly average of Rs 8,000-12,000 crore (Rs 80-120 billion) few weeks ago.
Soon after Mukherjee ended his speech, the yield on 10-year government paper shot up to 7.03 per cent. Yields have an inverse relationship with bond prices, so rising yields suggest that bond prices are falling.
But even before the fresh borrowing calendar was finalised, RBI and government officials have seen an increase in its workload.
With bond prices crashing, the first statement came from the finance ministry with Chawla telling reporters on Monday that at least half the Centre's gross borrowing would be through open market operations.
Minutes later, RBI Deputy Governor Shyamala Gopinath said borrowings would be undertaken in the least disruptive manner. Even on Tuesday RBI told bankers that it will ensure that government borrowing programme is conducted smoothly.
While this had a comforting impact on the markets as seen from less volatile trading in bonds (the yield on 10-year bench mark paper moved between 7.06-7.08 per cent), it was not sufficient to allay fears.
"The demand-supply mismatch has made a comeback. There is no great appetite to absorb so much of borrowing as banks are sitting with comfortable SLR holdingsĀ . The next direction will be known in the July monetary policy review and till then there will be pressure on yields," said Moses Harding, Head Global Markets Group at IndusInd Bank.
In a report, Standard Chartered bank noted that the government and RBI were making comforting statements for the market, but said, "considering the negative headline print on overall GoISec issuance, the central bank may have to come up with more concrete measures to placate negative market sentiment."
Though Chawla has said that at least 50 per cent of the borrowings would be through open market operations, what the market is looking for is how much would be the eventual borrowing.
In terms of options, RBI's has fewer tools at its disposal but bankers such as Corporation Bank Chairman and Managing Director J M Garg said that the central bank would first look at unwinding the market stabilisation (MSS) bonds and open market operations before exploring the prospects of reducing the cash reserve ratio and the repo rate.
"At present, there is sufficient liquidity in the system and credit offtake is low. Instruments such as CRR and repo rate would only be used if the liquidity situation tightens," Garg said.
Outstanding MSS bonds decreased to Rs 22,890 crore (Rs 228.90 billion) at the end of June from Rs 88,077 crore (Rs 880.77 billion) at the start of the year as RBI tried to ensure that government borrowed more without affecting the market.
But open market purchases have increased to Rs 43,159 crore (Rs 431.59 billion) at the end of June 26 against Rs 14,642 crore (Rs 146.42 billion) in the corresponding period last year.
The target for the first half of the current financial year is 80,000 crore (Rs 800 billion).
"The focus will now also be on supportive measures from the central bank, notably its open-market operation (OMO) purchase programme. Moreover, WPI inflation remains in negative territory, and we anticipate another cut to both the reverse repo and repo rates in Q3-2009.
This may provide some support for the bond market in what is otherwise likely to be a depressed environment in the near term," Standard Chartered said.
