Stimulus comes with a price
The news of the higher than expected government borrowing for the second half of fiscal 2011-12 drove up bond yields across segments. Ten year government bond yields rose 9bps while ten year corporate bond yields rose 7bps on the back of the borrowing announcement. The government is scheduled to borrow Rs 220,000 crores through issuance of dated government securities in the second half of fiscal 2011-12, higher by Rs 52,872 crores than the budgeted borrowing of Rs 167,128 crores. The government claims a short fall in small savings of Rs 27,000 crores as the factor responsible for the higher borrowing.
Government finances, which were extremely comfortable last year, are in a mess this year. The government was running a surplus balance throughout last year with the windfall gains of Rs 70,000 crores from 3G and broadband spectrum auctions. This year the government has consistently been in deficit with the RBI due to mismatch in revenues and expenditures. The result of government’s tight finances is the cost of borrowing for the corporates has gone up. Benchmark AAA corporate bond yields are up by almost 50bps fiscal year to date while yields for lower rated papers are higher by 75bps to 125bps. Corporates are finding it difficult to access the bond market, as markets are demanding high yields for lack of liquidity. Banks have also pushed corporates to the wall by hiking loan rates by a wider margin than even the rates quoted in the corporate bond market.
Overseas funding has also become expensive. The depreciation in the Rupee by 10% against the USD and the rise in credit spreads by over 200bps in the global credit markets have made overseas markets almost inaccessible to most of the corporates in India. Corporates in need of funds are pushed to the wall and are forced to pay exorbitant rates for funds. Corporates are also postponing capital expenditure as a result of lack of funds at reasonable rates.
The message to corporates is clear. Government sops and stimulus comes with a hefty price. Corporates run to the government for support when the going gets tough. Stimulus package, tax break etc. are all demands of corporates when they see a slowdown in sales or profits. The government obliged them after the credit crisis of 2008, by increasing spending to take up fiscal deficit by 3% to shore up the economy. Unfortunately, the government has never been able to fully roll back the tax breaks given to corporates as raising taxes is never seen in good light by the markets. Lower tax rates coupled with an expected slowdown in GDP growth in 2011-12 are keeping government finances tight.
The extra government borrowing of Rs 52,000 crores may not be as bad as it is made out be by knee jerk market reactions. Bond markets will initially find it difficult to digest the first Rs 15,000 crore auction in the first week of October and will demand higher yields in the auction. However, going forward markets will look at inflation trajectory and expected policy actions by the RBI for yield direction.
The next time corporate bodies run to the government for help, they should stop and think about the future repercussions. Unfortunately the damage is already done and many corporates unable to raise funds will go down the drain.