A little over a week after the RBI announced a slew of so-called ‘bazooka’ measures to offer relief to banks, corporates and the financial markets, the yield on the 10-year government bond has spiked to 6.45 per cent levels. A starker trend is the high cut-off yield on auction of state development loans (SDLs) on April 7. The auction, amounting to ₹37,500 crore across 19 States, resulted in State governments borrowing at a steep 7.7-8.3 per cent!
Currently, SBI’s one year MCLR (marginal cost based lending rate), against which various loans are benchmarked, is at 7.4 per cent, which is indicative of the preposterously high borrowing cost that the States are forced to endure.
The RBI’s measures were aimed at bringing down interest rates in the economy (very critical at this juncture) and ensure better transmission. It is ironical then that some of the States, such as Kerala (8.96 per cent for 15-year SDL), Rajasthan (8.3 per cent for seven years), Andhra Pradesh, Karnataka and Tamil Nadu (7.7-7.9 per cent across tenures) have had to borrow at a steep rate.
Costing dearly
Aside from slashing the policy repo rate by 75 basis points to 4.4 per cent, the RBI also unleashed various tools to ensure ample liquidity — cut in CRR, increase in MSF and targeted long term repo (TLTRO) of ₹1 lakh crore.
But despite these measures, the yield on the 10-year government bond has shot up to 6.4 per cent, a tidy two percentage points above the repo rate. The high borrowing cost for the Centre is a cause for worry.
April 7, result of the SDL auctions for 19 States, threw up a grimmer picture. SDLs of Andhra Pradesh were auctioned at a cut-off yield of 7.98 per cent for 11-year tenure. Kerala’s 15-year SDL was auctioned at a whopping 8.96 per cent, raising about ₹1,930 crore. Karnataka’s 11-year SDL to raise ₹1,000 crore came in at a high yield of 7.9 per cent. Given the already weak finances of States and the additional borrowings required to tackle Covid-induced crisis, the high interest cost burden is a big concern.
A steep rise in State borrowings in recent years has been a big worry. From ₹1.96 lakh crore in 2013-14, gross State borrowings shot up to ₹6.08 lakh crore in FY20. The quantum of total market borrowings by the State Governments for the quarter April-June 2020, is pegged at ₹1,27,205 crore, a 55 per cent jump from last year during the same quarter.
The uncanny rise in yields of Central and State government bonds has only made matters worse.
What gives?
The rise in government bond yields can be explained by various factors. One, the market is concerned over the supply of government bonds, amid the weak demand. The Centre has front-loaded its borrowing for FY21 (budgeted at ₹7.8 lakh crore), borrowing 63 per cent of annual target in the first half. Two, demand from foreign investors has been very tepid. FPIs have pulled out about ₹72,000 crore from Indian debt so far and are utilising just 37 per cent of their limits (only 1 per cent in SDLs).
Three, and importantly, risk aversion among domestic banks has been to such an extent that they have been wary of parking money even in quality bonds and debt instruments (recently money market bond yields had spiked by over 200 bps). Banks, fearing rise in yields and treasury losses, have been wary of investing in government bond yields too.
Lastly, it is now evident that the Centre will have to up its borrowings significantly (over and above the budgeted ₹7.8 lakh crore) to tackle the Covid-induced crisis and finance its fiscal deficit. Additional borrowings by the Centre and States are an added worry for the market.
Why is RBI behind the curve?
The longer the RBI waits, the bigger the problem becomes. The central bank is already way behind the curve in tackling the ongoing turmoil. The measures announced on March 27 have essentially put the onus on the banking system to provide funding and pass on rate benefits to businesses. But the heightened risk aversion and weak capital position of many banks are a big roadblock in providing much needed funds to small businesses and vulnerable sectors.
Providing direct lines of credit to select vulnerable segments (by the RBI itself) will be imperative, just as the US Fed did.
For now, immediately, the RBI needs to address the issue of rising yields. The RBI announced targeted long-term repo (TLTRO) where banks have to deploy the funds in investment grade (BBB rated and above) bonds, but do not have to mark-to-market these investments. This has helped ease the risk aversion of banks and has brought yields of corporate bonds to normalcy over the past week.
A similar dispensation for government bonds too may be required to ramp up demand for Central government bonds and SDLs. Banks can hold such investments as held to maturity (HTM), for a specified period of time.
Additionally, the RBI will also need to launch unlimited OMO (open market operations) programme to bring down the risk-free rate substantially. This is very critical as hardening of G-Sec and SDL yields has a cascading effect on other financial market instruments, impeding transmission and creating a vicious cycle.