The year 2019 was a year of recovery for the Indian markets. The credit crisis that started in late 2018 had consumed much of 2019 precipitated by increasing Non-Performing Assets (NPAs) in banks and Non-Banking Finance Companies (NBFCs). However, small sparks of recovery were being witnessed in the sector towards the end of 2019. Indian policymakers had to perform a difficult balancing act between providing a stimulus to boost growth and containing inflation while working with little fiscal space. As the economy was lumbering back to health, the COVID-19 lockdown halted this economic recovery in its tracks. Since March 2020, the country has been in a state of lockdown. There are many market participants who believe that the government has not met the fiscal deficit target for FY20 due to lower tax collection and underachievement of disinvestment targets.

The government has not disclosed the GST figures for April 2020. Normally these numbers are published on the first of every month. This is an indication that the revenue collection is drying up quick. On the back of these conditions, thegovernment announced additional borrowings of nearly Rs 6 lakh crore. Let us understand where this additional money can be absorbed. Commercial banks are the largest owners of government securities accounting for ~40 per cent of the total outstanding as on December 2019. Currently, banks are holding excess government securities over and above the statutory requirement. Second, the largest subscribers are the insurance and mutual fund entities. Combined, they account for about 26 per cent of the outstanding government debt. Recently, mutual funds have been seeing redemptions in debt and money markets instruments. Though there will be a shift towards G-Secs, it may not be very meaningful in context to the overall additional borrowing. Foreign Portfolio Investors (FPIs) have been reducing their long position in March and April in a bid to migrate to countries that are offering higher risk adjusted returns.

Who is going to buy the remaining supply?

The RBI may approach the current situation in more than one way. It could choose to simply remain passive and allow bonds yields to adjust. If it chooses to take action, then it could either buy bonds and not sterilize or engage in bond purchase and sterilize. These options will have different market implications. The expectation is that the RBI may buy government securities, as currently there is a supply-demand mismatch. The RBI has expanded its liquidity toolkit in the recent times from Open Market Operations (OMOs) alone to now using Long Term Repo Operations (LTROs), Targeted Long-Term Repo Operations (TLTROs), USD/INR FX swaps, reduction in cash reserve ratio, and 16 and 12-day variable rate repos. Depending on the route taken by RBI it would help decide the course of the yield curve.

Impact on Fiscal Deficit

The GDP is set to contract with all rating agencies havingrevised the GDP growth projections for FY21 drastically. The RBI has provided lower inflation target for FY21. The nominal GDP which was expected at 10 per cent during the budget will be far lower, having an implication on fiscal outlook FY21. Tax collection and disinvestment target, which are higher than usual, would be challenging for the government to meet. There maybe revision in spending to keep the deficit low. Impact on Fiscal Deficit