Will fiscal consolidation help bring down government borrowing?

At its Union Budget in February, the central government will set a fiscal deficit target for FY23 and economists expect it to be lower than that of the current year. In essence, the government would be able to walk the path to fiscal consolidation despite the spending burden a raging pandemic has brought. 

The government borrows from the bond market to make up for its deficit every year. Logically, fiscal consolidation or drop in fiscal deficit should bring down the market borrowing.

But it is unlikely that the bond market can heave a sigh of relief on supply in the coming years. Investors must brace for an elevated supply in the medium term even though the government may be able to bring down its fiscal deficit progressively either through increased revenues or reduction in spending.

That is because the central government will need to borrow to meet the repayments of its past market borrowings as also the interest cost on the same. The Reserve Bank of India’s (RBI) financial stability report pointed out that the central government’s bond repayments increase sharply in the coming years. “Repayment obligations (difference between gross and net borrowings) of the central government indicate a significant uptrend going forward, implying that gross borrowing is likely to remain elevated notwithstanding fiscal consolidation,” the report said. For instance, roughly Rs 4 trillion worth of bonds will mature in the next financial year (FY23). This means that the government will have to borrow at least Rs 4 trillion just to repay past dues. The redemption pile increases to as much as Rs 6.2 trillion by FY27. (See chart)

Further, the interest cost on the borrowings has also been increasing every year, partly due to the expansion of outstanding stock through new issuances and also episodes of rising interest rates. For FY22, the interest burden is estimated to be Rs 8.5 trillion (see chart). It is a given that the interest burden will continue to climb in the coming years.

To be sure, as the banker of the government, the RBI can deftly manage the borrowing through changes in tenures. Given that the yield curve is steep at the short tenures, the government can opt to borrow more from long-term bonds. That said, servicing its debt is going to be an uphill task for the government in the coming years due to the expansion in borrowing and the expected rise in bond yields.