The Borrowing Calendar and the Yield Spike
The finance ministry's debt office must fund a fiscal deficit of ₹9.2 lakh crore in the next financial year. Officials observe CPI inflation at 6.3%, above the RBI's 4% target; the repo rate is 6.50%; banking-system credit growth is 14.2% while deposit growth is 11.1%; and the 10-year G-sec yield has risen from 7.05% to 7.28% in a month. The government plans to front-load 62% of borrowing in the first half. An adviser proposes either (a) increasing small savings rates to attract households, or (b) shifting part of the borrowing to shorter-dated Treasury bills, or (c) requesting the RBI to conduct open market purchases. The finance secretary wants a judgement, not a definition, on which mix best limits crowding out of private credit while preserving inflation credibility.
1. Explain how front-loading 62% of borrowing could affect liquidity and private credit, using the deposit-credit gap.
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Front-loading raises the supply of government paper when banks already have a deposit–credit gap: credit is growing 14.2% against deposits 11.1%, so banks must bid for scarce deposits or wholesale funds. A heavy first-half calendar absorbs liquidity and pushes up yields; banks may pass higher funding costs to borrowers, crowding out marginal private investment. The effect is stronger if the RBI is simultaneously draining liquidity or if inflation limits rate cuts. It does not by itself prove crowding out, because insurers and pension funds may absorb duration, but the gap makes the risk material.
2. Evaluate the three proposals against the inflation and credibility constraint. Which is most defensible, and what condition would make it risky?
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Small-savings rate hikes are the least defensible: they are quasi-fiscal, sticky, and can blunt monetary transmission by keeping household rates above market. Shorter T-bills reduce duration and yield pressure at the long end but create rollover and refinancing risk; they do not reduce total absorption. OMO purchases can cap yields and inject durable liquidity, but with CPI at 6.3% they risk being read as fiscal dominance and can worsen inflation expectations. The most defensible is a calibrated mix: avoid aggressive long-end supply, use switch auctions and shorter tenors, and reserve OMO for liquidity shocks rather than routine deficit financing. It becomes risky if OMO is used continuously while inflation remains above target.
3. If the RBI declines OMO, what should the debt office do operationally to reduce crowding out?
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If OMO is unavailable, the debt office should reduce crowding out operationally: pre-announce a predictable calendar, diversify across tenors, use switch auctions to smooth redemptions, engage long-term investors such as insurers and pension funds, and avoid concentrating issuance in the long end. It can also use cash-management bills for short gaps rather than permanent absorption. The aim is to lower the liquidity premium and term premium without relying on central-bank purchases.