Govt borrowings plan will tell you the rates trend

The government borrows from the domestic bond market to finance its fiscal deficit — or the gap between revenues and expenditure.

The government also borrows to pay for bonds that mature during a financial year (which were borrowed in the earlier years).
Together, they constitute the government’s ‘gross borrowings’, while gross borrowing minus bond maturities during a year is its ‘net borrowing’.

Investors should look out for the borrowing number of Rs430,000 crore for cues on the direction of interest rates.

If the government intends to borrow much more than that number, it will be negative for rates because of the greater supply of bonds that this will spawn.

And vice versa.

It shows why deposit growth is critical for the absorption of government borrowing.

In times of high inflation, if interest rates do not sufficiently compensate fixed-deposit investors, deposit growth slows down.
This leads to lower demand for government bonds, which, in turn, leads to higher borrowing costs for the government.

Higher borrowing costs lead to higher interest outgo, leading to still higher borrowing in the coming years. This self-fulfilling cycle is detrimental to an economy.

The Reserve Bank of India had to step in to buy government bonds last year to fill the demand-supply gap (they said it was for liquidity management) and helped bond yields stay steady at higher levels.

The demand supply equation is highly susceptible to change if banks do not see deposits growing and liquidity in the system remains tight.

If the assumptions above hold, the government can exceed market borrowing expectations and still not face a demand-supply gap.

arjun@arjunparthasarathy.com