Govt borrowing cost may stay elevated as path to 4% inflation uncertain: Govt source

The government’s cost of borrowing is a key variable as it influences the rate at which private companies and households borrow from banks and the market.

The Indian government’s cost of borrowing may stay elevated for the next six months amid uncertainties over the trajectory of inflation and when it will return to the Reserve Bank of India’s (RBI) target of 4 percent, a government official said.

“Yield on the 10-year benchmark bond may continue to stay over 7 percent,” the official, who did not want to be identified, told Moneycontrol. “We had hoped that there may be one rate cut this year, but with inflation inching up again, the chances of that are low. The battle against inflation may last longer.”

India’s central bank raised the benchmark repo rate by 250 basis points (bps) to 6.5 percent in 2022-23, but has kept it unchanged so far in 2023-24 as Consumer Price Index (CPI) inflation fell sharply, hitting a 25-month low of 4.31 percent in May. However, data for June released on July 12 showed inflation had snapped a four-month falling streak and risen to 4.81 percent, higher than economists’ expectations of 4.6 percent. One basis point is one-hundredth of a percentage point.

The central government’s benchmark 10-year bond was trading at 7.08 percent at 2:30pm on July 17. It was trading below the 7-percent mark  in early June .

The government’s cost of borrowing is a key variable as it influences the rate at which private companies and households borrow from banks and the market. Over the last three years, the centre has borrowed record amounts from the market through the issuance of bonds. However, yields have not shot up commensurately thanks to the injection of record liquidity by the RBI.

This year, the centre intends to borrow Rs 15.43 lakh crore in gross terms, leading to questions about the government crowding out the private sector at a time when corporate investment continues to be subdued. Gross borrowing includes monies borrowed in the year, plus repayments due.

Even as the RBI’s Monetary Policy Committee (MPC) maintained the status quo on interest rates in April and June, it warned that it stood ready to take further monetary action “promptly and appropriately” as needed to keep inflation expectations firmly anchored and to bring it down to the 4 percent target.

The central bank’s tone about reaching the medium-term target has also become stronger of late, with Governor Shaktikanta Das saying last month that inflation being within the tolerance band of 2-6 percent “is not enough”.

CPI inflation has been above 4 percent for 45 months in a row.

Rising inflation and bond yields

A spike in vegetable prices, led by tomatoes, has sparked concerns about the near-term inflation path.

“Worryingly, in the first 10 days of July, tomato prices are up 240 percent month-on-month (MoM), while onion and potato prices are up 14.3 and 9.3 percent, respectively, over June,” Kaushik Das, Deutsche Bank’s Chief Economist for India & South Asia, said on July 13 after the release of inflation data for June.

“If the current food price trend sustains through the month, then food inflation will likely be up 3.6 percent MoM in July, which will likely push the headline CPI inflation above the 6 percent mark in July and August,” Das added.

The government has been forced into action to tackle food prices. On July 16, the Ministry of Consumer Affairs, Food, & Public Distribution said wholesale prices of tomatoes had fallen after it had sold them at a concessional rate of Rs 90 per kg across the country. It is now selling them at Rs  80 per kg.

While this may ease some pressure on households, economists remain concerned about the impact of inflation on government bond yields.

“In the coming months, yield on the 10-year benchmark paper is poised to touch 7.2 percent with inflation inching up,” Madhavi Arora, Lead Economist at Emkay Global Financial Services, told Moneycontrol.

According to CRISIL economists, the yield on the benchmark 10-year bond may be in the range of 7.05-7.15 percent at the end of September.

Further upward pressure on bond yields may come in the form of rate hikes by the US Federal Reserve. According to the aforementioned government official, with one or two more rate increases expected from the US central bank this year, there is little room for yields to fall below 7 percent anytime soon.

While US inflation sharply cooled in June to a two-year low of 3 percent, per the CME’s FedWatch tool, the prices of Fed funds futures suggest a 96 percent chance of a 25-basis-point rate hike by the Fed later this month.