Govt borrowing will surprise on the upside

The nominal GDP base has gone up by 20.3% to Rs78,77,000 crore levels, with inflation, as measured by the GDP deflator, at 9.6% levels.

The fiscal deficit for 2010-11 based on the revised nominal GDP figures (original estimates were Rs69,00,000 crore based on a 12.5% growth assumption) is 4.8% of GDP from budgeted estimates of 5.5% of GDP.

The higher base of nominal GDP does not bode well for government borrowing.

Assuming a 14% nominal GDP growth for 2011-12 (with real GDP at 8% and inflation at 6%), a fiscal deficit projection of 4.5% will lead to a net borrowing of Rs404,000 crore or a gross borrowing of over Rs475,000 crore.

The market was expecting a gross borrowing of around Rs430,000 crore based on a fiscal deficit projection of 4.8% on a nominal GDP base of Rs69,00,000 crore. The market will now have to rework its demand estimates on a higher borrowing amount.

The other negative factors hitting the market are spike in oil prices on the back of unrest in Libya and the highly hawkish tone of the technical advisory committee (TAC) on the monetary policy.

Brent crude prices have crossed $110 a barrel on worries of supply disruptions in Libya. The high oil prices translate directly on to the subsidy bill of the government. High subsidies coupled with selective fuel price hikes lead to rising inflation expectations.

The TAC minutes released by the RBI suggested that more rate hikes are in store as the committee is focused on quelling sharply rising inflation expectations.

The economic survey for 2010-11 released on February 25 suggested that a sustained policy tightening is necessary for bringing down inflation expectations. The market should start factoring in another 75 to 100 basis points (bps) hike in repo and reverse rates for the fiscal 2011-12.

The market tried to go positive into the budget with benchmark bond yields touching lows of 8.08%, but as news on Libya unfolded and the minutes of the TAC were released, bond yields gave up their gains.

Bond yields still managed to close the week with slight gains, but those gains will vanish and yields have the potential to spike up once the borrowing numbers are released.

Interest-rate swap yields rose with five year OIS (Overnight Index Swap) yields rising by 12bps week on week. Swaps are factoring in rate hikes and tight liquidity conditions but are yet to factor in higher than expected borrowing figures. Corporate bond yields stayed at higher levels and will follow government bond yields post budget.

Liquidity eased last week on the back of bond redemptions of Rs17,000 crore with daily average borrowings by the system from the RBI dropping by Rs25,000 crore.

Liquidity will ease further in the first week of March on the back of government spending but will then steadily tighten due to advance tax outflows and traditional fiscal year end demand for funds by the system.

Government bond auction

There were no government bond auctions held last week.