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Will Borrowings Suck Liquidity?

Author: Dasari Sreenivasa Rao/Wednesday, February 3, 2021/Categories: Exclusive

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Will Borrowings Suck Liquidity?

The Prime Minister Narendra Modi-led NDA government is in capital expenditure (capex) mode as the Union Budget-2021 focused solely on growth factor. The Union Finance Minister Nirmala Sitharaman announced an ambitious target for gross market borrowings at Rs12.05 lakh crore. The higher than expected target for borrowings is, though surprised many on Dalal Street, much needed for the Centre to support increased government expenditure on infrastructure projects. However, two questions arise at this juncture—Can the Centre meet the borrowings target? And the second question is how it would affect the liquidity in the domestic markets?
Let’s explore the second question. The domestic stock markets had been moving up due to the foreign liquidity mostly. There was no correlation of stock market rally with GDP or any other economic fundamentals. In fact, spending on infrastructure projects will boost banking, FMCG, steel, cement and other stocks. However, higher borrowings will impact debt markets, but the situation is not alarming with the declining inflation rate and supportive measures from the Reserve Bank of India (RBI). The main concern for the economy is the surge in government’s debt. 
Coming back to the first question: The NDA government says the target is achievable given the performance in 2020-21 fiscal. Despite the turbulent Covid-19 impact, the net borrowing was Rs10.56 lakh crore as against gross borrowing target of Rs12.88 lakh crore for FY21. The original estimate for gross market borrowing for 2020-21 financial year was Rs7.8 lakh crore and net borrowing was Rs5.44 lakh crore. Later, the Centre increased the borrowing target to Rs12 lakh crore and again to Rs13.1 lakh crore owing to the Covid-19 impact.
Ecowrap, a part of SBI, stated that the gross borrowing is at Rs11.46 lakh crore as on January 22, 2021. The Centre wants to mobilize Rs80,000crore additionally for FY21. The total debt outstanding at the Central government as on September 2020 was Rs107 lakh crore. G-Secs account for Rs66 lakh and Treasure Bills for Rs11 lakh crore.
As the central government tries to normalize liquidity levels in the domestic markets, funds mobilization is an unavoidable measure for the government. It helps the Centre to intervene in the markets whenever necessary. It’ll also determine a new trading band for sovereign securities, observes a market analyst.
On the positive side, the surplus cash reserves at the Centre is also rising thanks to the improvement in tax collections. It’s estimated that the cash reserves rose to Rs3.40 lakh crore as on January 28, 2021, from Rs1 lakh crore in September 2020. This has helped the government lower the target of borrowings to Rs12.05 lakh crore and net borrowing at Rs9.17 lakh crore, said a senior official from the Finance Ministry. Borrowings against small savings amounted to Rs4.8 lakh crore in 2020-21 fiscal and Rs4 lakh crore in the current fiscal. However, the borrowing cost from these sources is a bit high. Another concern for the economy is the increasing amount of interest i.e. debt servicing. The interest expenditure for the 2021-22 fiscal, as mentioned in the Budget, is at Rs8.09 lakh crore, which is 17 per cent more than the current fiscal. Interest component is based largely on revenue expenditure.

External Deficit Financing
On the expected lines, the Budget announcement confirmed that the market borrowings would remain at an elevated level, even as external deficit financing is set to increase. According to India Ratings and Research (Ind-Ra), the gross market borrowings of the Central government to be Rs 10.82 trillion and net market borrowings to be Rs 9.02 trillion in FY22.
In FY21 (April-November), the Central government has already borrowed Rs 12.16 trillion against its revised borrowing target of Rs 12 trillion.
Ind-Ra in its latest report stated that “the accommodative monetary policy stance, weak corporate sector demand, excess banking sector liquidity, higher savings especially by households, and higher external financing (mainly borrowing from multilateral institutions such as the World Bank) helped the government to fund its deficit smoothly and reduce pressure on domestic interest rates. 
Generally, India is not financing its deficit by raising sovereign bonds. But it borrows from multilateral donor agencies to benefit from a long tenor and low cost.
During 2005-2020, the proportion of fiscal deficit financed by external borrowing ranged from 0.8 per cent (FY19) to 11.8 per cent (FY05). The amount of external borrowings varied from Rs55.2 billion (FY19) to Rs235.6 billion (FY11). In FY21 (April-November), 3.6 per cent of the fiscal deficit was financed by external borrowings, up 442.3 per cent on a year-on-year (YoY) basis.
Ind-Ra predicts external financing of fiscal deficit to the tune of Rs 670.5 billion in FY22. The World Bank and its group committed $5.13 billion to India in 2020 from an average of $3 billion during 2017-2019.
In 2021, the World Bank group has already made commitments for $1.04 billion.
The banking regulator RBI had infused massive liquidity into the banking system to fight against the impact created by the Covid-19 pandemic. As the economic activity is returning to normal, now, the RBI wants to drain part of the liquidity from the market. If it does so, it will impact the latest decision announced in the Budget to borrow more, remarked an analyst. The market borrowing target by the finance minister will further act as an obstacle for RBI in drawing down the huge surplus of cash from the financial system. Recently before the Budget, RBI carried out a 14-day variable rate reverse repo auction to drain some liquidity. But it impacted the stock markets and forced RBI to ease the situation by taking up open market purchase of bonds to provide some breather to investors.

FII outflows
During the entire pandemic year of 2020, the inflows from foreign institutional investors (FIIs) propelled the key indices to the record highs. Latest few sessions of selling by FIIs might have spooked markets, but most foreign players are interested and stay invested in India's equity market.
The domestic markets recorded 4-5 sessions of offloading by FIIs to the tune of Rs 6,800 crore from the equity markets. This was considered as the longest exit spree since March and September. However, FII investments are at Rs1.35 lakh crore since November 2020.  Analysts observe that concerns over the Centre's stand to expand fiscal spend in the Budget FY22 to usher in faster growth as one of the reasons for FIIs to exit. Other analysts consider this as profit booking. 
After investing continuously to Rs 1.25 lakh crore in the market from November-January, FIIs withdrew only Rs 6,000 crore. So, nothing to worry, they said. 
All the major factors like Biden presidency, vaccination drive, Q3 results have all been factored in apart from the Budget 2021-22. However, these are early days and if prepared smartly than the Budget can also give a further upside to the FIIs to remain invested.
Though FPIs are sellers these days, their quantum of selling is still not very large. They seem to be of the view that the Indian markets' valuations now seem to be fair and upside from here may be limited. Till the corporate earnings growth momentum picks up and sustains, this feeling may sustain, said analysts.
Global flood of liquidity along with near zero interest rates in foreign markets, a faster-than-anticipated domestic macro recovery, expectations of healthy Q3 results and an expedited vaccine roll-out programme will continue to encourage FIIs to stay invested in Indian stocks. Analysts term profit booking as a healthy correction. Generally, corrections make the market healthier and rebound. The markets were apprehensive of some possible new taxes, like the rumored Covid Tax before the Budget announcement. 
Luckily there were no such tax proposals in the Budget and FIIs will resume investment with a bang. If this happens, short covering can take the Sensex again beyond 50,000. Other factors such as volatility rise due to monthly expiry and Union Budget 2021 might be the factors leading the FIIs to book their profits. Naturally, investors turned cautious ahead of the Budget. Also, weak global sentiments are leading to the uncertainty in the markets globally.
As part of its fight against the financial crunch caused by Covid-19, RBI resorted to lower interest rates and injected more liquidity into the market. The central bank ensured liquidity over Rs8 lakh crore into the domestic financial system during the pandemic year of 2020. 

Borrowing Cost
At a time when RBI is taking measures to drain excess liquidity that it pumped into the financial system in 2020, it's impacting the borrowing costs. The yield on 3-year rupee bonds rated BBB rose to 28bps (basis points) and it was the biggest rise since 2018. 
As the RBI drains out liquidity from the financial system, it’ll increase the borrowing costs for corporate India, said the market analyst. Indian companies will have to mobilise funds from Indian rupee bond market and if the yields are higher then it'll be a higher cost of borrowing for domestic companies, he explained. As soon as the RBI announced its decision to restore normal liquidity level in the financial system, the cost of borrowing started rising upwards. If the borrowing costs are higher, then it'll impact the lower-rated companies to refinance debt and honour near-term maturities, elaborated the analyst.
The fiscal stimulus plans announced by the Centre benefited the small companies as they got financing at cheaper interest rates. RBI wanted to absorb excess liquidity of over Rs2 lakh crore from the domestic banking system via 14-day reverse repurchase auction. Already yield on 10-year G- securities rose 15 bps to 6.06 per cent. Further, the higher than forecast on market borrowings and fiscal deficit, the fixed income market will get a jolt. If RBI doesn't support markets, then pressure on yield remains intact, said the analyst. RBI has also revised its borrowing calendar for Rs2.2 lakh crore. And weekly borrowing operations to be continued till the end of 2020-21 financial year. Generally, the annual borrowing exercise concludes by mid-February.
Economists want the borrowing exercise along with a long-term fiscal deficit programme to be taken up. The Centre had very effectively handled the pandemic situation by providing excess liquidity and lowering interest rates. The sustainable economic recovery is possible only through prudent fiscal deficit management, they said.
“The gross borrowing from the market for the 2021-22 fiscal would be around Rs 12 lakh crores. We plan to continue with our path of fiscal consolidation, and intend to reach a fiscal deficit level below 4.5 percent of GDP by 2025-2026 with a fairly steady decline over the period,” Finance Minister Nirmala Sitharaman said while unveiling Budget 2021-22 in Lok Sabha on Monday. Gross borrowing includes repayments of past loans. Repayment for past loans in the next financial year has been pegged at Rs 2.80 lakh crore. The government raises money from the market to fund its fiscal deficit through dated securities and treasury bills.
As a result, net borrowing would come down to Rs 9.24 lakh crore for the next fiscal, while for the current fiscal it is estimated at Rs 10.52 lakh crore during 2020-21. Hard-pressed for funds to combat rising coronavirus infections, the government in May increased its market borrowing programme for the current financial year by more than 50 percent to Rs 12 lakh crore. The FM further added that “we would need another Rs 80,000 crores, for which we would be approaching the markets in these two months. To ensure that the economy is given the required push, our BE estimates for expenditure in 2021-2022, are Rs 34.83 lakh crores. This includes Rs 5.54 lakh crores as capital expenditure, an increase of 34.5 percent over the BE figure of 2020-2021.”

The writer is a business journalist with 27 years of experience

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