The government funds over 90% of its fiscal deficit through issue of dated government bonds. A rising fiscal deficit implies higher government borrowing that in turn leads to pressure on interest rates. At a time when the economy is slowing down with all indicators including IIP (Index of Industrial Production) growth of 0.1% for the April-December 2012 period pointing to GDP growth slowing to decade lows, it is difficult for the government to curtail its borrowing. The primary issue countries such as Spain are facing is that the weak economy is making it impossible for the government to adhere to strict fiscal norms enforced by the EU (European Union).
Indiaâ€™s GDP growth estimate for 2012-13 is placed at 5% by the CSO (Central Statistical Office), based on data available up to November 2012. The government is hotly contesting the growth estimates but the fact is even a 5.8% growth is a ten year low. The slowing economy has pushed up fiscal deficit numbers to 5.3% of GDP for 2012-13 against budgeted estimates of 5.1% of GDP. However despite a higher fiscal deficit the government is not borrowing more than the budgeted amount of Rs 569,000 crores. The reason the government is not borrowing more to fund the higher fiscal deficit for this year is that it has seen an increase in small savings, which it did not budget for in its initial borrowing estimates.
The government is running a cash surplus of around Rs 80,000 crores as of February 2013 and is looking to carry forward the cash surplus into fiscal 2013-14. The cash surplus will help the government borrow less for the coming fiscal and the lower borrowing will ease pressure on markets to absorb the supply and also ease pressure on the RBI to buy government bonds. Government bond purchases by the central bank is inflationary in nature and inflation expectations will trend down on the back of the RBI refraining from buying government bonds.
Lower government borrowing will bring down yields on government bonds as market demand-supply dynamics turn in favor of demand. The corporate bond market will have more access to funds as lower government borrowing places less pressure on liquidity. Falling interest costs for corporate will help improve investment demand in the economy.
The government borrowing math
How does the demand and supply for government bonds stack up? Table 1 gives the demand supply maths for government bonds in India. The assumption for 2013-14 is that the government will borrow a gross amount of Rs 529,000 crores.
Table 1. Government Borrowing MathsÂ
The year 2012-13 saw RBI taking up 26% of the gross borrowing of the government. Banks bought Rs 180,000 crores of government bonds that constituted 23% of deposit growth of 13.5% assumed for full year 2012-13. Bank deposits had grown by 13.1% as of 25thÂ January 2013. FIIâ€™s have bought around Rs 25,000 crores of government bonds fiscal year to date while the other including insurance companies, provident funds, mutual funds and corporates have bought a total of Rs 214,000 crores of bonds.
The lower government borrowing for the year 2013-14 could easily be absorbed by the market without RBI requiring to intervene. Banks are likely to invest 23% of their incremental deposits in government bonds assuming a deposit growth of 14.5%, which should be the target growth for the year. FIIâ€™s should utilize the full limits of USD 25 billion on the back of expectatiosn of bond yields coming off. FIIâ€™s have unutilized limits of Rs 34,000 crores as of end January 2013. The others category is likely to see a significant jump in government bond purchases as traders and investors shore up their bond holdings on expectations of fall in interest rates
The government borrowing math shown in Table 1. is dependent on RBI lowering the repo rate in fiscal 2013-14, inflation coming off in the economy and liquidity becoming comfortable in the system.
The hope for the markets in 2013 is that the worst is over for the global economy. Data has been mixed suggesting that the turnaround is not yet fully certain. On the negative side, GDP growth data for the US showed 0.1% fall in GDP growth for the fourth quarter of 2012 while Japanâ€™s third quarter 2012 GDP growth fell for the third straight quarter. Japanâ€™s GDP growth for the December quarter of 2012 fell at an annualized rate of 0.4% while the countryâ€™s September quarter growth was revised to an annualized rate of -3.8%. Economists had estimated a 0.4% growth for the Japanese economy in the December quarter.
Chinaâ€™s fourth quarter 2012 GDP growth at 7.9% helped the economy register a full year growth of 7.8%. Chinaâ€™s economic growth for 2012 is the slowest in thirteen years. Eurozone is likely to have shrunk in the forth quarter of 2012 as economies from France to Spain suffer flat to recessionary growth due to spending cuts.
Data has been positive on other counts. Manufacturing data from China to the Eurozone has been positive for January 2013 while the US continues to see jobs being added in the economy. Chinaâ€™s exports grew by 25% in January 2013 while US retail sales rose for the third straight month.
The question is will data turn more positive or more negative going forward? Markets are suggesting that the worst may be over with strong gains in equities in the beginning of calendar 2013. It is likely that markets could be proved right as central banks continue to pump in money to shore up economies.
Table 1. Key Economic Indicators