Flip-flopping on government borrowing
Jolt to state-owned banks is as disturbing as the lack of clarity on signals to the bond market
In just about three weeks, the Union finance ministry changed its mind on its borrowing programme. On December 27, it announced its plan to borrow an additional ~500 billion from the market, hinting at the possibility of a slippage in meeting its fiscal deficit target of 3.2 per cent of gross domestic product or GDP for 2017-18. On January 17, it announced that its additional borrowing would be only ~200 billion, a 60 per cent reduction.
What changed in the space of just three weeks that the Union government could significantly reduce its additional borrowing programme? The official reason was that a reassessment of the government’s ‘revenue receipts and expenditure pattern’ helped it take that market-moving decision. Sensex, the benchmark index of the Bombay Stock Exchange, scaled a new high and the yields on the 10-year government bonds fell, the biggest single-day decline since November 2016.
Market participants in Mumbai, though, were not impressed with the rationale put out by the finance ministry. Government bond yields have been rising steadily in the last few months, in anticipation of a slippage in the government’s deficit requiring it to borrow more. The yields for 10-year government bonds have risen from 6.4 per cent in August 2017 to 7.4 per cent at the start of January 2018. And once the government announced on January 17 that its additional borrowing plan was cut by 60 per cent, the bond yields fell.
The state-owned banks, which subscribe to a bulk of these bonds, have reasons to be upset by such a sequence of events. With elevated yields at the end of December and a corresponding decline in the prices of bonds, these banks had to book marked-to-market losses for the period ended December 31, 2017. They are now wondering if the government had reassessed their revenue receipts and expenditure pattern a little earlier, before December 31, 2017 and had made announcements to that effect, their pain on account of marked-to-market losses would have been considerably less.
This is hurting them as it came soon after they were rapped over the knuckles by Reserve Bank of India (RBI) Deputy Governor Viral Acharya, who advised them to plan their bond purchases more efficiently and not expect any regulatory forbearance to bail them out of a financial setback on account of a fall in bond prices.
Regulatory warnings, perhaps, these banks could stomach! But when these state-owned banks saw that even their principal shareholder, the Union government, also failed to time its announcements in a way that they get some relief, they certainly had some reason to complain. After all, state-owned banks are the largest buyers of government bonds. Their lack of interest in or a reduced appetite for such bonds can adversely affect the government’s borrowing programme. Indeed, the last few bond auctions failed to elicit the desired response as many state-owned banks stayed away from the auctions.
There is of course no logic in bailing out state-owned banks for their over dependence on government bonds, which is a reflection of their lazy banking practices. But two issues of considerable concern have arisen out of the current sequence of events.
The RBI deputy governor’s tough message came within days of the government announcing its additional borrowing programme. That message would have been more credible and effective if the RBI and the finance ministry had paved the way for a separate debt management office taking care of the government’s borrowing programme. The fact is the RBI continues to manage the government’s borrowing programme, giving rise to a conflict of interest. Shouldn’t both the finance ministry and the RBI expedite the creation of a separate agency for overseeing the government’s bond auctions so that statements made by the RBI on aspects of bank regulation carry greater weight and credibility?
There is yet another issue of concern. If the finance ministry knew that talks were going on with the RBI to persuade it to transfer some more surplus to the exchequer and that its expenditure pattern (read savings on spending) could reduce its additional borrowing requirement, was there really any need to jolt the bond market with a ~500 billion additional borrowing plan? Or were the two announcements in the space of three weeks aimed at managing the bond market’s expectations, even if the stateowned banks took a collateral hit?
Either way, the government needs a more transparent and effective strategy for communicating with the bond market and coordinating with the RBI. In the current situation, both of them are crucial for implementing the government’s borrowing plan. There is as much need for structural reform to create a new body for managing its bond auctions as for a more transparent strategy to improve coordination with the RBI and communication with the bond market.