As a borrower, you have reason to cheer now as lending rates have started moving downwards. But not-so-long-ago you also saw rising interest rates burn a hole in your pocket. While the yo-yoing of rates may make life difficult for you, the government, which is the biggest borrower, has little reason to complain.
This is because in spite of increased borrowings over the years, the average cost of borrowing for the government has remained stable at 7.8-8 per cent since 2011. In laying out its medium-term debt management plan last week, the Centre aims to continue to borrow at low cost by planning its borrowing needs well in advance and avoiding risk.
Since 2010, there have been two rising rate cycles and two falling ones. As borrowers, your lending rates too have risen and fallen during this period. But for the government the interest rate it pays on its outstanding debt has hardly moved.
For instance in the period between March 2010 and October 2011, when the RBI raised repo rates by 375 basis points, banks increased their base lending rates by 275 basis points.
But the weighted average coupon rate — interest paid on the outstanding debt — for the government remained rock steady at 7.8 per cent during this period.
Even in recent times, when policy rates went up from 7.25 per cent in May 2013 and remained at 8 per cent through 2014, the government’s cost of borrowing did not budge. The weighted average coupon rate on outstanding debt remained in the 7.9-8 per cent range. Banks increased their base lending rates by 30-40 basis points during this period, before slashing them in 2015.
Savvy borrower
So how has the Centre managed to shrug off spikes in market rates? By planning its bond issuances in advance and offering the right mix of instruments to investors, the Centre has been able to keep costs at bay. The RBI is assigned the task of managing the Centre’s borrowing. After estimating its borrowing requirement for a particular year, the Centre puts out its bond issuance calendar for market borrowings in advance for each half year, with details of the quantum to be borrowed each week, range of maturity (tenure of the bond), etc. Around five days before the auction, bonds along with the issuance size is made public. This has helped the Centre successfully complete its borrowings at a reasonable cost.
Spacing out its borrowing plan through the year also helps it iron out interim spikes in rates and reduce its average cost of borrowing. Much like investors who gain on averaging their cost of investment over a period of time through systematic investment plans (SIPs).
This practice will be continued during the Medium-Term Debt Management Strategy (MTDS) period — a plan that the Centre intends to implement over three- to five years to reduce cost and risk on borrowing.
In the 2015-16 Budget, the Government estimated its gross borrowings at Rs 600,000 crore for 2015-16, a tad higher than the Rs 5,92,000 crore for 2014-15. So far it has exhausted about 85 per cent of this limit.
One of the other reasons for lower cost of government borrowing has also been the captive ready market for these bonds by banks for meeting their Statutory Liquidity Ratio (SLR) requirement. This, to some extent, has kept rates suppressed.
The right fit
To ensure that there is ample demand for government bonds, the Centre also plans its borrowings keeping in mind different investors’ appetite. For instance, banks that are dominant investors with 43 per cent share in total debt, prefer short to medium tenure bonds and hence a considerable amount of issuances are done in this category. Longer tenure bonds are issued for meeting the demand of insurance companies and provident funds.
The Centre, however, plans to reduce short-term issuances in the coming years as part of its MTDS to reduce risk.
Lower risk
Aside from lowering cost, the Centre has also been working towards reducing its risk by reducing redemption pressure. By increasing the maturity of bonds issued, the Centre has been able to reduce roll-over risk. The weighted average maturity of new issuances has been consistently up from 11.16 years in 2010-11 to 14.6 years in 2014-15.
In its Medium-Term Debt Management Strategy, the Centre plans to lengthen the maturity even more to reduce the roll-over risk. The high concentration of debt (58.5 per cent) in the less-than-10-year maturity category will be brought down 55 per cent by 2020-21.