India surprises with higher borrowing; yields surge

India increased its bond sale target for the financial year to make up for a shortfall in a government scheme for small savers, spooking investors already girding for extra borrowing to fill an anticipated fiscal gap.

New Delhi will borrow 2.2 trillion rupees (USD 44.9 billion) in the second half of the fiscal year, the government said on Thursday, significantly more than expected, sending bond yields and swap rates higher.

Investors had been expecting additional borrowing, if any, to be around 200-300 billion rupees. They also had expected the government not to release its additional borrowing plan until after its budgeted market bond issuance was completed, which was on track to happen in January or February.

But, Economic Affairs Secretary R. Gopalan said government borrowing in the second half of the fiscal year would be 528 billion rupees higher than had been budgeted in February.

Samiran Chakraborty, chief economist at Standard Chartered Bank in Mumbai, said he expects a further 400 billion to 600 billion rupees in additional government bond issuance during this fiscal year, which ends on March 31.

"The deterioration in government fiscal balances has yet to be discovered or communicated to us," he said.

"The bigger problem is still going to hit us," he said.

Slowing growth in Asia's third-largest economy and rising interest rates to fight high inflation have put pressure on government finances. New Delhi, which set a target to raise 400 billion rupees from state company share sales in the current fiscal year, is far behind schedule on that target.

Gopalan declined to comment on whether the government would reduce its disinvestment target.

However, he said the additional borrowing unveiled on Thursday does not change the government's fiscal deficit target of 4.6% of gross domestic product for this fiscal year.

Cash shortage

The additional borrowing was spurred by lower-than-projected government cash balances resulting from a shortfall from the previous year, as well as a smaller-than-expected pool of deposits held by the government for small savers.

"There has been a huge deficit in the small savings this year. I have to replace one source of finance with another source of finance," a finance ministry official said, declining to be identified.

Kumar Rachapudi, a fixed-income strategist at Barclays Capital in Singapore, said savers were lured away from the government scheme by higher rates in bank deposit accounts.

"I expect yields to be capped now. Market will start expecting open market operations also and the global situation too is not great," he said after Indian federal bond yields hit a two-month high on Thursday.

The unnamed official told reporters that the government would announce bond buybacks on the open market if required.

The benchmark 10-year bond yield closed up 10 basis points (bps) at the day's high of 8.44%. The benchmark 5-year swap rate rose as much as 14 bps to 7.17% and the one-year rate rose 8 bps at 7.98%.

Market watchers were divided on whether New Delhi would announce more additional borrowing for the current fiscal year.

"I would assume there would be no risk of a further raise in borrowing later in the year as 528 billion rupees extra borrowing figure must have been arrived by taking all factors into account," said Vivek Rajpal, a fixed-income strategist with Nomura in Mumbai.

In its February budget, New Delhi pencilled in gross market borrowing of 4.17 trillion rupees for the 2011/12 fiscal year to help bridge a fiscal deficit that is forecast to be at 4.6% of the GDP.

It completed borrowing of 2.5 trillion between April and September, and the full-year borrowing now stands at 4.7 trillion rupees.