RBI financial stability report flags risks to public debt profile

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Financial risks associated with the public debt profile may hamper the functioning of fixed income markets, the Reserve Bank of India (RBI) said on Thursday.

A credible strategy to ensure debt sustainability calls for reducing primary deficits, the central bank said in its financial stability report.

In the report, the RBI warned that while the gap between interest rates and the growth rate has been broadly favorable over the past three decades, tighter monetary policies around the world risk eroding this advantage.

“At the end of March 2021, the stock of general government debt (Central and States) peaked at 89.4% of GDP and is expected to remain at elevated levels through 2025-26,” the RBI said in the report. .

“This will likely keep a growing supply of issues in the market, putting pressure on yields and consequently crowding out the private sector from the financial resource envelope.”

Government borrowing has grown at a rapid pace over the past two years as the Center eased budget deficit targets to boost spending and heal the economy from the scars of the Covid crisis.

As a result, sovereign bond yields rose sharply as the supply of debt stretched the market’s absorptive capacity. Government bond yields are benchmarks for borrowing costs across the economy.

The government announced a record gross borrowing program of Rs 14.95 trillion in the current financial year, significantly higher than the Rs 10.47 trillion borrowed in the previous year.

Taking into account the debt transfer operations that have been carried out, the Centre’s gross bond sales for the current year are forecast at around Rs 14.3 trillion.

The Center aims to reduce its budget deficit to less than 4.5% of GDP by 2025-26, from a target of 6.4% this year.

In 2018-2019 (April-March), the Ministry of Finance amended the Fiscal Responsibility and Budget Management Act and set a target of 60% for the debt-to-GDP ratio by 2024-25.

Subsequently, the Fifteenth Finance Committee, under the chairmanship of NK Singh, suggested lowering the debt-to-GDP ratio to 85.7% of GDP in 2025-26 from 89.8% of GDP in 2020-21. .

The size of the debt-to-GDP ratio has been a major constraint reported by rating agencies when it comes to upgrading India’s sovereign rating.

In the Financial Stability Report, the RBI said that in FY22, the weighted average yield on government bond issues increased by 49 basis points year-on-year.

“Going forward, yields may continue to reflect risk premia, with spillovers to the private sector via higher funding costs,” the RBI said.

The RBI has also flagged the risks associated with the massive government bond buybacks planned over the next financial year.

“….larger repayment obligations of Rs 3.08 trillion in 2022-23 compared to Rs 2.86 trillion the previous year continue to weigh on the evolution of yields.

“In the short term, more frequent rolling of treasury bills, the stock of which rose to 9.99 trillion rupees as of June 10, 2022, from 24 trillion rupees in March 2020, could tighten market conditions going forward. .”


EXTERNAL PADS

In the Financial Stability Report, the RBI said that due to the accumulation of large foreign exchange reserves over the past few years, several indicators of external vulnerability show improvement from the “taper tantrum” period. of 2013.

“This bodes well for mitigating external risks and global spillovers,” the central bank said.

Over the past fiscal year, foreign exchange reserves increased by $30.3 billion due to net inflows of external commercial borrowing, improved bank capital and large net foreign direct investment, it said. the RBI.

While overall reserves declined to $590.6 billion on June 17 from a record high of $642.5 billion in September, the current level of reserves is equivalent to nearly 10 months of projected imports for the current year, the RBI said.

This provides sufficient protection against external shocks, the central bank said, adding that the rupiah has proven to be one of the stable currencies against peers since the war in Ukraine broke out in late February.

So far in 2022, the rupee has weakened by 5.9% against the US dollar – a lesser depreciation than some other emerging market currencies and significantly less than the roughly 20% depreciation seen during the crisis. crisis.

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