Government finances are again in a mess. The government is issuing cash management bills to tide over a temporary cash crunch. Cash management bills are issued when the government is overdrawn on its WMA (Ways and Means Advances) limits with the RBI. The WMA limit is fixed at Rs 30,000 crores for the July to September 2011 quarter. Hence, issue of cash management bills suggest that the government is overdrawn with the RBI by over Rs 30,000 crores. One of the reasons for the overdraft is the maturity payment for the 9.39% 2011 bond that matured on the 2nd of July. The bond had an outstanding amount of Rs 37,000 crores.
The issue of cash management bills is over and above that of advance tax receipts and weekly government bond auctions, suggest that government finances are strained. The RBI had provided for the bond redemption by scheduling government bond auctions for a total of Rs 63,000 crores for July, including the auction of Rs 15,000 crores held on the 1st of July. The government had received advance tax of over Rs 35,000 crores in June and that was to have bolstered government finances. Despite auctions and advance tax receipts, the government is auctioning cash management bills for Rs 8000 crores this week. The government had auctioned cash management bills for Rs 6000 crores last week.
The strained government finances are in sharp contrast to the surplus the government had throughout fiscal 2010-11. The government was flushed with funds from the receipts of 3G and broadband spectrum auction. The government received over Rs 100,000 crores from the auctions. The strain in government finances is worrying the bond market. Bond yields went up by 10bps week on week on the back of issue of cash management bills. The market will worry about higher than budgeted borrowing by the government if government finances continue to be strained.
Government spending benefits liquidity. Government running an overdraft with the RBI, adds primary liquidity into the system. The improved system liquidity is reflected in yields of money market papers coming off. One year CD (Certificate of Deposit) rates have come off by 50bps from highs seen a month ago while three month CD rates have come off by over 120bps from highs. The system is still accessing the RBI LAF (Liquidity Adjustment Facility) window for funds, with bids for repo at 7.50% averaging Rs 80,000 crores on a daily basis. Bids for repo should come down this week on the back of bond maturity and government spending.
Bond markets while worrying about government finances, will look at the environment surrounding interest rates, in determining direction of yields. There are indications of demand coming off in the economy due to rising interest rates. Vehicle sales growth slowed down to 3.9% in June on a year on year basis. Manufacturing PMI (Purchasing Managers Index) came in at a nine month low in June. Credit growth is down to 20.7% on a year on year basis, from levels of 23.5% seen six months back. Commodity prices have corrected with the Reuters CRB commodity index down 8% from highs seen a few months ago. Oil prices have come off by over 10% from highs. Issues of global growth slowdown are reflecting on oil prices. If the slowdown theme begins to gather steam bond yields will benefit, as the market will factor in RBI’s policy rates being held steady. Bond yields are not likely to trend higher from current levels of 8.32%, which is the yield on the benchmark 7.80% 2021 bond, given slowdown indications.
Government bond auction
The government auctioned Rs 15,000 crores of bonds last week. The bonds auctioned were the 7.83% 2018 bond for Rs 3000 crores, the 7.80% 2021 bond for Rs 6000 crores, the 8.26% 2027 bond for Rs 3000 crores and the 8.30% 2040 bond for Rs 3000 crores. The cut offs came in at 8.39%, 8.36%, 8.64% and 8.65% respectively. The government is scheduled to auction Rs 12,000 crores of bonds this week.
The government auctioned cash management bills for Rs 6000 crores last week. The cut off on the thirty five day bills came in at 8.09%. The government is auctioning forty two day cash management bills for Rs 8000 crores this week.