Govt borrowings may put pressure on interest rates

A major factor for the rise in interest rates last year was due to the heavy government borrowing at high interest rates. This created damages on two fronts: the interest rate moved up while on the other hand government borrowing crowded out private sector from the market. “Last year the rise in call money rates was followed by a high interest rate regime which played havoc in the system. The government can afford to borrow at high interest rates not private parties,” said a money market source.

As Finance Minister P Chidambaram announced in the Union Budget, the government has a targeted net borrowings of Rs 33,820 crore. Any change in interest rates on securities will have its impact on general long-term interest rates as the former is the benchmark. “During 1995-96, interest rates on market borrowings shifted upward across maturities in contrast to a downward shift in the previous year. The maximum coupon rate on a 10 year government dated stock rose from 12.35 per cent in 1994-95 to 14 per cent in 1995-96,” says the Reserve Bank of India.

The RBI move to mop up dollars from the market by pumping in equivalent amount of rupees is expected to soften the impact of government borrowings. “The mopping up of dollars will add to liquidity in the banking system. Of course, now liquidity situation has improved and interest rates have come down. Obviously RBI and the government don’t want to repeat what has happened last year,” banking sources said.

The central bank on an average mops up around $ 100 million from the market on any given day. The foreign currency reserves have jumped by around $ 3 billion after the presentation of the budget and the forex kitty has now reached the $ 23 billion level. Even after mopping up dollars heavily, the call rates went up last week showing that the interest rates are still vulnerable to upward movements. “The RBI seems to be preparing the ground for the government to borrow from the market in a big way. We will be inviting an high interest rate period once again,” they said.

The RBI and the government will have to tread cautiously as previous experience has shown that government profligacy has led to high interest rates. The corporate sector was the biggest casualty as this coupled with liquidity crunch cut into the bottom lines of many companies. The only consolation this time is that the government can now bank on high forex level, low inflation and a decline in interest rates to soften the borrowings. But, even this is only to an extent.

It is a tight situation once again. It will be very difficult for the government to cut down spending. Corporates are waiting for interest rates to come down further.