All ruling parties seek to open the public spending tap in their last year before elections. But that option may be closing for the Narendra Modi government. The reason isn’t just high global crude prices and a weak rupee, which, far from helping raise additional resources to fund a splurge, is fuelling demands for cutting duties on petrol and diesel.
A bigger worry is the growing challenge to government borrowings for financing even budgeted expenditures.
During April-June, the Centre borrowed Rs 144,000 crore through primary auction sales of government securities. Not only was this below the Rs 183,000 crore for the same quarter last year, but Rs 8,018.72 crore out of the total Rs 144,000 crore devolved on primary dealers, who bear the risk of under-subscription in auctions.
Even these lower borrowings were at a much higher cost. The last auction of a 10-year bond, on June 29, fetched a yield or interest payable of 7.89 per cent. Compare this to the 6.52 per cent yield on a security of the same maturity auctioned a year ago.
However, it isn’t the Centre alone that is struggling to borrow. In a market where banks have limited appetite to buy government paper – their investment in such securities, at 30.17 per cent of aggregate deposits, is already above the mandated statutory liquidity ratio of 19.5 per cent – and foreign portfolio investors (FPI) have also turned net sellers, state governments are at the receiving end as well.
The states together were to raise market borrowings of Rs 115,600-128,100 crore during April-June, as per the original indicative calendar worked out with the Reserve Bank of India. But all they have managed to mop up is Rs 76,587.7 crore – and at far higher rates.
For example, in April-June 2017, the Uttar Pradesh government paid 7.52-7.67 per cent on 10-year state development loans. The corresponding rates ranged even lower for others such as Kerala (7.20-7.64 per cent), Gujarat (7.20-7.63 per cent), Tamil Nadu (7.23-7.63 per cent), Punjab (7.20-7.63 per cent) and Rajasthan (7.22-7.51 per cent). Still better were Maharashtra and Telangana; they could borrow for 15 years and 20 years at 7.18 per cent and 7.16-7.70 per cent, respectively.
The latest-ended quarter, by contrast, saw yields on 10-year state loans surge to 8.39-8.45 per cent for UP, 8-8.41 per cent for Kerala, 7.77-8.25 per cent for Gujarat, 8.05-8.37 per cent for Tamil Nadu, 8.34-8.62 per cent for Punjab and 8.16-8.44 per cent for Rajasthan.
Even relatively cash-rich Telangana had to fork out 8.15-8.22 per cent on 20-year borrowings. High yields also prompted states to reject bid amounts in some auctions.
Two things have happened here.
The first is that banks, the main subscribers to government bonds, aren’t any longer flush with cash, unlike in the post-demonetisation period when there were no takers for the deluge of deposits with them.
It’s quite the opposite now, with bank credit growth at about 12.7 per cent year-on-year. Besides, in a scenario of rising interest rates, banks suffer “mark-to-market” losses on their existing bond holdings (as there is less demand for these securities issued at lower coupons, leading to a fall in their prices), making them reluctant to participate in auctions.
Secondly, with FPIs becoming net sellers, the debt market has lost an important source of liquidity. In 2017, FPIs were net buyers of Indian debt to the tune of $23.02 billion (Rs 148,806.53 crore), which has reversed to net sales of $6.12 billion (Rs 41,397.20 crore) so far this calendar year.
Rising global interest rates, due to unwinding of easy-money policies by the US Federal Reserve and European Central Bank, coupled with the rupee’s weakening, has resulted in an FPI exodus from the debt market.
All this has made borrowings harder and costlier both for the Centre and states – in a year leading to elections. Worse, there’s still a lot of even normal borrowing to be done.
The Modi government has budgeted gross borrowings of Rs 605,539 crore through issue of dated securities for 2018-19. The Centre usually completes around 60 per cent of its borrowings during April-September, so as to ease pressure on the markets in the “busy” second half when demand for private credit goes up.
This time, though, the Finance Ministry chose to borrow just Rs 288,000 crore or 47.56 per cent of the total budgeted amount in the first half, which was also below the Rs 372,000 crore mobilised during April-September 2017.
That decision, in late-March, was taken given the prevailing volatility in bond markets and revenues from the new goods and services tax system not fully stabilising. These uncertainties were expected to settle by the second half. What was not bargained for was a further worsening of the environment – with regard to oil, the rupee and capital flows.
“There is renewed concern over both fiscal and current account deficits. The Centre and states will find it more difficult to borrow in the coming days. The tyranny of the financial markets will put a cap on electoral populism,” said a senior research analyst with a top global investment firm.
“Increasingly, markets are imposing constraints on excess spending by governments and their running fiscal imbalances,” noted Neelkanth Mishra, India Equity Strategist with Credit Suisse.
The difference between now and five years back, the earlier-quoted analyst added, is that the “bond market has learnt to price risk, creating yield differences between Central and state securities, and also between states themselves”. That will, of course, have implications for elections.