The Government’s decision to chop and change its market borrowing programme for FY19 is a watershed event for the domestic bond market with implications for government finances. In the last three months, a spirited tug-of-war has been on between the RBI, which manages the public debt programme, and bond market participants in the periodic auctions. While the RBI has been trying to place long-dated g-secs (government securities) at lower-than-market rates, bidders have resisted, resulting in a series of cancelled auctions. The RBI is understandably keen to rein in the Centre’s borrowing costs after the market yield on the 10-year g-sec shot up by over 130 basis points in the last six months. But the markets are fretting over a demand-supply mismatch after the Government overshot its fiscal deficit target in its budget, and proposed mammoth gross borrowings of ₹6.06 lakh crore for next year. Lately banks, already sitting on excess SLR, have been reluctant buyers of g-secs. Foreign Portfolio Investors (FPIs) have exhausted RBI caps, and other buyers have shied away from long-term bonds to avoid losses. In the circumstances, the Centre’s decision to tweak its borrowing programme deferring to poor sentiment, is pragmatic.

The implications of its changes are threefold. One, market borrowings for FY19 will be scaled down, with ₹25,000 crore to be borrowed from the National Small Savings Fund (NSSF). While higher reliance on the NSSF is welcome news for retail savers in post office schemes, this is unlikely to reduce the Centre’s borrowing costs. Some of these schemes already carry high rates and are pegged by formula to prevailing market yields. In the coming months, it will be interesting to see if the Centre sticks to the formula or takes ad hoc decisions to prune rates. Two, sovereign borrowings will now be back-ended, with 52 per cent planned for the second half of the fiscal. This will stay the Government’s hand in pump-priming the economy over the next couple of quarters. For the second half, the Government seems to be counting on the return of banks and FPIs to the market. But this is highly contingent on the behaviour of global interest rates and domestic credit offtake. Three, there are plans to issue more short-term securities, floating rate bonds and inflation-linked bonds to replace long-dated bonds. The wider menu is positive for market development, but will expose government debt to rate volatility.

While a spike in the Centre’s borrowing costs is not good news for taxpayers, it is not altogether a bad thing for domestic borrowers. For too long, Indian governments (both Centre and States) have been shielded from the consequences of fiscal profligacy by their iron grip on the bond market through banks and the RBI. With the grip now loosening, they too may get a taste of how domestic borrowers and MSMEs grapple daily with high interest costs and rate volatility.