Analysts ask for clarity at the earliest to calm bond yields

While there is no official word yet, deficit monetisation can potentially be in the range of Rs 4-5 lakh crore.

Keeping in mind the shortfall in net tax receipts and the need to stimulate the economy, the Centre and the Reserve Bank may decide on quantum of deficit monetisation as early as by September end to reduce uncertainties in the bond market and mitigate the pressure on government bond (G-secs) yields, analysts have said. While there is no official word yet, deficit monetisation can potentially be in the range of Rs 4-5 lakh crore.

According to former chief statistician Pronab Sen, the government needs to stimulate the economy by spending Rs 4-5 lakh crore more than the Budget estimate of Rs 30.4 lakh crore in FY21. He is of the view that there could be Rs 3 lakh crore shortfall in net tax revenues. India Ratings chief economist D K Pant is also sceptical about the government meeting Rs 2.1 lakh crore disinvestment target and sees a shortfall of Rs 1.5 lakh crore under this head.

After over 70% year-on-year fall in net tax receipts in April-May, the worst affected months due to Covid-induced lockdown, the decline has narrowed to 22% in July. The Budget estimate entails a net tax revenue growth of 21% year-on-year in FY21 over the actual of FY20.

The revenue shortfalls and additional stimulus requirements entail a resource requirement of Rs 8.5-9.5 lakh crore over and above the likely Budget revenue receipts in FY21, analysts said. Due to a huge decline in revenue receipts, the government recently enhanced FY21 borrowing by Rs 4.2 lakh crore to Rs 12 lakh crore, which will likely be scaled up, they added.

The government may have to borrow another Rs 4-5 lakh crore, which the RBI may have to monetise directly/indirectly by subscribing to the issuances or buying G-secs in the secondary market.

Some economists are also of the view that direct monetisation is a better option to keep the G-sec yields below 6%, with some seeing 10-20 bps drop in yields provided the government and the RBI give clarity at the earliest on monetisation.

The 10 year G-sec yield rose from 5.78% on August 3 to 6.12% on August 31 – a 34 bps rise, which could have been averted had the RBI intervened in time, said Mahendra Jajoo, chief investment officer – fixed income at Mirae Asset Investment Managers (India).

World over, the benchmark 10-year government bond yields are ruling currently at around the lowest level in the past quarter century in most large economies, including US (0.67%), UK (0.18), Japan (0.02) and South Korea (-0.6%). Whereas, India’s lowest 10-year G-sec yield was at 5.05% on April 1, 2004 compared with the current yield of 6.03% (September 11). Deficit monetisation at a lower interest rate would also help the government bring down expenditure on interest from 23% (FY21BE) of total expenditure, the highest among large economies.

On August 31, the RBI announced measures such as special open market operation, liquidity infusion through long term repo auction and increase in limit of hold to maturity securities to cool down yield to 5.8%. However, it has again appreciated to slightly over 6% due lack of clarity from the government and RBI on further increase in borrowing by the Centre. “For the yield curve to flatten that clarity has to come to the market,” Jajoo said.

After the recent revision of the Centre’s borrowing programme, its fiscal deficit for FY21 stands at 5.7% of GDP, against budgeted 3.5%; however, the big decline in revenue will likely take the deficit to around 7% of GDP, even without any expenditure compression from the budgeted level.

Due to a much higher degree of uncertainty faced by the economy, indirect monetisation can also lead to a situation where the yields may harden in the short run due to higher risk perceptions, including on inflation front.

“That is why, a proper monetisation makes more sense… in direct monetisation one is not working with market rates, but with a negotiated yield between government and RBI,” Sen said. India Ratings’ Pant agrees with Sen’s view.

A section of policy makers are of the view that the RBI’s balance sheet, one of the least leveraged in the central banks of the world, can do it easily. While Bank of Japan’s and Swiss National Bank’s assets are over 100% of their respective GDP’s as the world’s top two most leveraged central banks, the RBI’s is only at 24% of GDP. They believe that the RBI can potentially monetise by another 10% of GDP, still be among the lowest in the world. A decision on monetisation of debt is likely by end-September when the finance ministry and the RBI thrash out the borrowing plan for the government for H2.

The dilemma on deficit monetisation is not unique to India, with few Asian central banks already participating in their respective debt markets through private placements as well as secondary markets as governments face sharp rise in deficits and record rise in public debt levels, said Radhika Rao, economist at DBS Bank.

“There is a small probability of direct debt monetisation by the central bank in second half of FY21, when the full picture of the deficit and, by extension, size of borrowings becomes clearer after taking into count the H1 issuance as well as funds raised by the green-shoe option,” Rao said. “We see another 10-20bps downdrift in yields, with a sharper correction only likely to be triggered by a stronger response by the authorities.”