Gilt mkt could see demand-supply mismatch despite index inclusion: UTI MF

UTI MF, however, believes that even this may not be enough to balance out the scales of demand and supply in the government bond market as heavy redemption pressure lined up in coming years implies that the gross supply of gilts is likely to remain uncomfortably large.

“There is a possibility of a substantial demand/supply gap for sovereign bonds despite assuming a $30 billion inflow from FPIs post index inclusion. Given the substantial maturities in the upcoming years, borrowing could remain under pressure even in future years without meaningful central bank support,” the fund house wrote.

Many market participants believe that the Centre is likely to announce the inclusion of Indian sovereign debt in global indices in the Union Budget for 2022-23 (Apr-Mar), scheduled on February 1.

While the government has made headway regarding the process over the last few months, traders said that issues surrounding taxation – particularly long-term capital gains tax and withholding tax still need to be ironed out before the inclusion of bonds in a global index can be formally launched.

Latest data on the Reserve Bank of India website showed government securities worth a whopping Rs 3.8 lakh crore are set to mature in the next financial year, while the repayment obligation for the next year stands at an even more mind-boggling Rs 4.5 lakh crores.

Given that the Centre’s fiscal deficit, which surged during the COVID-19 pandemic as the government sought to spend more to repair economic growth, is unlikely to decline meaningfully anytime soon, market borrowing is therefore expected to remain elevated. The government’s gross borrowing for a particular takes into account the net cash requirement plus redemptions.

UTI MF pegs the total net market borrowing of the Centre and state governments at Rs 15.9 lakh crore in the next financial year as against Rs 20.2 lakh crores in the current financial year.

Taking into account the projected demand from various segments, including foreign portfolio investors, the fund house estimates a Rs 4.37 lakh crore gap in demand and supply that would need to be filled in by commercial banks. The calculation assumes deposit growth of 10 per cent for the current financial year and the next.

Indian banks are mandatorily required to maintain a portion of their net demand and time liabilities – a proxy for deposits- in government securities as part of the Statutory Liquidity Ratio. UTI MF assumes that banks may invest an incremental 20 per cent of their deposits in central and state government securities in the next financial year.

“One of the possible ways the Centre is looking to plug the borrowing gap is to raise resources through asset monetisation. An aggregate monetisation potential of Rs 6 lakh crore, over four years, from 2021-22 to 2024-25, is estimated under the National Monetisation Pipeline, with an indicative value of Rs 0.88 lakh crore envisaged for the current financial year. However, the actual realisation will depend on the quality of execution,” the fund house said.

As the market enters the new calendar year and the final quarter of the current fiscal, UTI MF foresees a greater degree of unpredictability in the money market curve, particularly if the RBI commences on the implementation of fine-tuning policies announced in December.

The central bank, in its policy statement last month, said that it would move the auction route for variable rate reverse repos as the primary method of liquidity absorption from January.

Recent actions on the liquidity front by the RBI suggest that the central bank desires overnight rates to align themselves to the repo rate of 4.00 per cent instead of the reverse repo rate of 3.35 per cent.

The reverse repo rate has dictated the cost of funds for banks for around a couple of years due to record surplus liquidity in the banking system.

“ In addition, usual final quarter balance sheet expansion related borrowing by financial institutions, credit-related supply from corporates coupled with expectations of stance change/normalization from RBI in April 2022 policy could keep things precarious initially,” UTI MF wrote.