Budget 2022: Bond market gets a steep bill from government

Budget 2022

When the Central government spends, the bill comes due to the bond market. For FY23, this bill will be the highest ever – at Rs 14.95 lakh crore on a gross basis. That is the Centre’s market borrowing estimate for the next financial year.

India’s 10-year government bond yield surged more than 20 basis points in reaction to this potential supply glut and settled at 6.83 percent. Bond yields move inversely to prices.

To start with, the expectation was the government wouldn’t be able to reduce its market borrowing for FY23 even though the fiscal deficit was expected to narrow from the current fiscal year. Indeed, the fiscal deficit target for FY23 is 6.4 percent of gross domestic product, compared with the revised estimate of 6.9 percent for the current year.

Bond investors expected the government to borrow a high amount next year too, simply to meet the redemption of bonds issued earlier. But the redemption pile is not the whole explanation behind the 43 percent surge in gross borrowing. Adjusted to repayments, the net market borrowing works out to Rs 11.2 lakh crore, which is 32 percent higher than in the current year.

The key reason is that the government expects a fall of 28 percent in funds garnered through national savings schemes, thereby putting most of the financing burden on market borrowing.

Even as the supply is expected to surge, finding buyers for bonds appears challenging because the two key buyers – foreign investors and the Reserve Bank of India – may not participate in a big way in FY23.

Global indices

Capital gains exemption for bonds, a key requirement for inclusion in global bond indices, especially in Euroclear, was missing in the budget. It is estimated that inclusion in the indices would have lured almost $10 billion of investments into Indian bonds.

“One of the key expectations was capital gains exemption for bonds, which would have added certainty to the Euroclear index inclusion,” said B Prasanna, head of treasury at ICICI Bank. “But there has been no announcement with regard to this or even index inclusion. If the exemption had happened, the bond index inclusion would have been closer. There is as such no clarity on index inclusion yet.”

Market participants were hoping that foreign investors would fill the gap expected to be left by the RBI. The central bank has turned a net seller of bonds of late from being a net buyer. In FY22, the RBI bought Rs 1.4 lakh crore of bonds, much lower than the over Rs 3 lakh crore it purchased in FY21.

What’s more is that rising inflation and a general increase in bond yields across the globe have made the RBI more tolerant of an increase in domestic bond yields. Bond investors said this tolerance would continue in the coming months.

Prasanna expects the RBI to avoid bond purchases because it may seem odd in the context of its policy reversal.

“Based on the monetary setup and the fact that the fiscal policy is pro-growth, the RBI ideally would have to tighten its purse. It is a matter of time for the RBI to start its withdrawal. At this time, to do an OMO (open market operation) to support the bond market is unjustifiable from the macroeconomic perspective,” he said.

That said, a cat-and-mouse game between the RBI and the bond market would ensue yet again.