Investors are growing resigned to the expectation that India will issue more bonds than budgeted in the second half of the year and are focused on how much new paper will be issued and whether market buying by the Reserve Bank of India (RBI) will ease the pain.
While finance ministry officials have made repeated statements that New Delhi intends to stick to its fiscal deficit aim of 4.6% of GDP in the year that started in April, most private economists expect it to overshoot the target, which may force it step up market borrowing to fund the shortfall.
The government plans to borrow a gross Rs 4,17,000 crore (USD 92.9 billion) in 2011/12, of which Rs 2,50,000 crore, or 60% of the full-year target, is scheduled to be completed in the first half, leaving room for increasing borrowing in the second half.
Most market participants believe the government will increase its market borrowing by Rs 30000-70000 crore, depending on its fiscal performance.
Cuts in duties on crude and other petroleum products along with a hike in state-set fuel prices for diesel, kerosene and cooking gas unveiled late last week are expected to add to pressure on government finances.
"Additional borrowing is expected but it is not reflected in the prices so far. But it's surely there at the back of everyone's mind. No sane trader will disagree with that," said the head of trading at a private bank, declining to be named.
Goldman Sachs expects India's net market borrowing this fiscal year to be around Rs 400,000 crore, significantly higher than the budgeted Rs 3,43,000 crore, it said in a note.
On Tuesday, a senior finance ministry official told Reuters the government was keen in maintaining its fiscal deficit target but needs to work on how it would do that.
Standard Chartered Bank revised its fiscal deficit target for the fiscal year that ends in March to 5.4% of gross domestic product from 5.1% earlier to reflect India's large subsidy burden.
"Lower revenue collection owing to slower GDP growth, smaller-than-budgeted disinvestment proceeds, and higher expenditure could potentially push the deficit to 5.8% of GDP, hurting market sentiment, unless the government seeks other ways to raise revenues," economists at Standard Chartered wrote.
RISING YIELDS
India's benchmark 10-year bond yield has risen 34 basis points so far this fiscal year due to ongoing issuance and interest rate hikes, despite global risk aversion prompting investors to purchase safe-haven government debt.
"There is a chance that additional borrowing will be done, but any announcement to that effect will likely be made only in the second half of the fiscal year," said Kumar Rachapudi, a fixed income strategist at Barclays Capital in Singapore.
The Reserve Bank of India may mitigate the impact of added government borrowing by buying bonds through open market operations (OMO) later this year to infuse liquidity into parched fixed-income markets, dealers have said.
"We also expect RBI to start buying back securities starting September, so to my mind, market reaction to additional borrowing should not be too negative. However, it depends on the quantum of both additional issuance and open market operations, more importantly the timing of the buybacks," Rachapudi said.
Traders broadly expect a sell-off of 5-10 basis points in bonds and swaps if the government increases borrowing along with central bank purchases. Increased borrowing without accompanying RBI purchases would be viewed more negatively.
Rising bank deposits, which lenders must offset by holding government securities, is also expected to help take up supply of bonds from a satiated market.
"Additional borrowing, if any, will be known only in the second half of the year. So the market will cross the bridge when it comes to that," said Manish Wadhawan, director and head of rates at HSBC India.
(USD 1 = 44.9 Indian Rupees)
