Uncertain inflation path may keep bond yields above 7%; more buybacks likely in May

The government is projected to borrow Rs 14.13 lakh crore via bonds in FY25

The cost of Indian government borrowing may stay elevated thanks to delays in interest rate cuts across the world owing to uncertainties surrounding the inflation trajectory, said a finance ministry official. This, despite buying back securities after around six years to ease liquidity, which was expected to lower bond yields.

"Rate cuts are not happening across the world, be it the US, UK, or  India, and the conflict in the middle east is still on. Given these, yields are likely to stay above 7 percent," the official said, adding that the government had expected the yield on the 10-year benchmark paper to ease below the 7-percent-mark owing to the lower borrowing programme for this fiscal.

The last time the yield on this bond fell below the 7-percent mark (currently hovering around 7.03 percent) was in June 2023.

Higher bond yields mean that the government has to borrow at higher rates, increasing the government’s borrowing cost.

Of the gross market borrowing of Rs 14.13 lakh crore projected for FY25, the Centre will borrow Rs 7.50 lakh crore (53.08 percent) in the first half of the current fiscal. This is sharply lower than the Rs 15.43 lakh crore borrowed in FY24.

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.

Therefore, the finance ministry had expected a sharper fall in the cost of borrowing given the relatively lower amount expected to be raised from the bond market this fiscal. On top of that, attempts to ease liquidity through buyback of securities was also seen to help lower yields, the official added.

According to the official, "the liquidity and interest rate situation is preventing yields from coming down. Bond buybacks are being conducted to ease liquidity for the next 5-6 months given that tax flows are good. We will keep doing buybacks for another month or so."

The RBI bought back bonds worth Rs 10,512.99 crore at an auction last week versus Rs 40,000 crore worth of securities on offer, with the central bank rejecting most bids. It is buying back an additional Rs 60,000 crore on May 16.

The government repurchases bonds based on its cash position, especially when tax revenues are better than expected. This helps them use excess funds to retire debt.

The trajectory of inflation has remained a major concern for governments across the world, including India. Though the Consumer Price Index (CPI) print eased to 4.83 percent in April, food prices edged higher, limiting the fall in the overall headline figure.

This delays a rate-cut action from the Reserve Bank of India, given the aim of bringing down CPI inflation to the 4-percent target.

According to Barclays, since the momentum in domestic growth is still relatively robust, the central bank would likely see little reason for monetary easing, adding that the first rate cut by the Monetary Policy Committee (MPC) may potentially come in December, rather than October, 2024.