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New Delhi: By selling 187 billion dollars of government debt, India has gone on history however this massive transaction is currently straining the bond market. Although the government claims that this borrowing is necessary to help the government finance development and to contain spending, experts feel that this borrowing would make bonds less appealing to investors in the short run.
Government debt refers to the money which the government borrowed out of the market through selling bonds. Banks, insurance companies, mutual funds, and foreign investors are mostly the ones who purchase these bonds. The government, in its turn, agrees to pay interest and pay money back after a certain period of time. The level of borrowing by India is the highest this time and that is the reason why everyone has been watching it.
The primary cause of such a massive sale of debt is the increased costs of the government. India is investing more on infrastructural projects such as roads, rail, ports, and digital projects. Defence spending, the welfare schemes, and payments on the old loans are also increased. To handle all these, the government chose to borrow in the market more.
When bonds supply is however intense, the prices tend to decrease. An increase of the prices of bonds also leads to an increase in the yields or returns of the bonds. This increases the cost of borrowing to the government in future. It also impacts the banks and companies since the interest rate in the economy may increase. Consequently, home and car loans as well as business loans can become expensive.
According to market experts, bond investors are turning out to be cautious. Such heavy borrowing is feared to make bond yields long term high. The foreign investors are also keeping a close eye on the fact that the emerging market such as India is already losing money due to higher bond yields in the United States and other countries.
Inflation is another issue. A high inflation rate may not force the Reserve Bank of India to reduce the interest rates rapidly. This would put additional strain on bonds. As long as interest rates remain elevated, the bond prices tend to be low and this is not a good news to the current bond holders.
This situation also impacts on banks. Because the government bonds are high in quantity held by the banks, depreciation in their values can affect their balance sheets. Though the banks tend to keep these bonds to maturity, tension still prevails in the market.
On the up side, there are experts who hold the view that the high economic growth of India can be used to sustain this huge borrowing. India is also one of the most rapidly developing large economies in the world. The government finances might be sustained by strong tax collections and constant demand in the long term.
The government has done this by assuring the markets that it will be careful in borrowing and be in fiscal control. According to the authorities, the majority of borrowing will find productive applications, which can be useful in generating future revenues.
Bond markets will be very keen in following the data on inflation, decisions by RBI, and the direction of world interest rates in the next few months. Although record debt sale indicates trust in the growth story of India, it is also a wake up call to investors that excessive borrowing can cause short term torture to the bond market.
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