India finds bond market hard to tame

India finds bond market hard to tame

on September 27, the Indian government had some very good news for those interested in sovereign bonds. it announced that its borrowing would remain unchanged at ₹12.04 lakh crore. that is, it won’t be borrowing any more money for the rest of this financial year. further, it will subsume the ₹84,000 crore loan needed for providing GST compensation to states within the residual market borrowing. 

in normal times, this would have been a spur for bond yields to cool down. but several local and global factors have them on an unsure footing.

why does government borrowing matter?

first, let’s understand how the government raises debt.  typically, it’s by issuing long-term bonds over 5-year, 10-year, 15-year or longer periods. a bond is essentially an ‘IOU’ from the government, ie. an assurance that the borrowed amount will be repaid at the end of that term along with the interest offered. now, depending on the terms of issuance, these ‘sovereign’ bonds can be purchased by businesses, individuals, and even foreign institutions or direct investors. they also often come with certain tax benefits and fairly lucrative yields in order to encourage more people to lend to the government.

another thing to remember is that bond prices and bond yields are inversely proportional. the higher the bond price, the lower its yield and vice-versa.

the basic principle of supply and demand applies here too. if a government is increasing its borrowing, it will have to issue more bonds. thus, the supply of bonds increases, and their price falls. consequently, bond yield increases. a higher yield implies a greater burden on the government to pay back in the future.

now, with the government saying it will not be borrowing further in FY22, one would expect the supply of bonds to reduce, their price to increase, and yield to drop. but it appears that might not happen.

why is that?

a significant amount of sovereign bonds fall in the 10-to-14-year maturity period. their share of overall government borrowing is expected to drop from 46% in FY21 to 44% in FY22. the shortfall and plenty of the remaining share will be fulfilled by the supply of state development bonds and even corporate bonds. (yes, the central government isn’t the only issuer of bonds.) their yields are expected to remain fairly stable or at least not fall steeply anytime soon.

further, the announcement on no further borrowing largely applies to five-year bonds. thus, even if yields are to fall, they will impact a much smaller portion of the overall bond market.

another factor is that the government’s plan depends on the success of its ₹1.75 lakh crore divestment plan. any shortage there, and it could be forced into borrowing again, pushing yields upward.