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India may borrow more in 2006-07, bonds to suffer

India's budget for the next financial year to be unveiled at the end of February may require higher borrowing to pay for welfare projects.

india Updated: Feb 17, 2006 15:40 IST

India's budget for the next financial year to be unveiled at the end of February may require higher borrowing to pay for welfare projects, which is bad news for the bond market and government funding costs, analysts said.

Bond prices are already suffering because interest rates have risen and investors' cash has dried up, and some analysts say plans for higher borrowing for the year that starts on April 1 could drive yields up to their highest level in four years.

The communist-backed coalition government's budget will be presented to parliament on Feb 28.

A survey of six analysts showed a median forecast for gross borrowing in 2006/07 of 1.53 trillion, 10 per cent higher than the 1.39 trillion in the previous budget.

"In the first quarter of the next financial year, due to the increased borrowings, bonds would be under pressure and we could see the 10-year bond yield touch 7.50-7.75 per cent," said A Prasanna, a debt market analyst at ICICI Securities.

The benchmark 10-year yield was at 7.33 per cent on Friday. It has risen nearly 65 basis points since the start of the financial year last April.

Over the same period the central bank has raised its benchmark short-term interest rate by 75 basis points to 5.50 per cent to fight price pressures in the fast-growing economy.

"The domestic interest rate cycle is on an upturn and the government's cost of borrowing will continue to rise," said Rupa Rege Nitsure, chief economist at Bank of Baroda.

"The rising interest costs will weigh on finances which could be stretched by increased spending on populist schemes."

The weighted average yield of bonds issued by the federal government, an indicator of interest costs, rose to 7.29 per cent between April and January, up from 6.03 percent in the same period a year earlier, data from the central bank shows.

The government taps the domestic market to fund nearly 70 per cent of its fiscal gap. The deficits of the central government and India's states combined was equivalent to 8.3 percent of gross domestic product in 2004/05, among the highest in the world.

Deficit target

Finance Minister Palaniappan Chidambaram is expected to boost spending on health and other social sectors in the coming fiscal year. At the same time he is expected to try to rein in the fiscal deficit by collecting taxes from more people and businesses, particularly the rapidly growing service sector.

Last year, he outlined plans for nearly $6 billion of social spending, including funds to improve rural infrastructure and an employment guarantee scheme for the poor.

Due to India's slow-moving bureaucracy, hardly any of that money has been spent, leaving the government with surplus cash, but the schemes will still be a burden in the new fiscal year.

"In view of the implementation of welfare programmes like the plan to improve rural infrastructure and rural employment guarantee scheme, it is obvious the expenditure for next year is likely to rise by about 15 per cent," said Shubhada Rao, chief economist at YES Bank, Mumbai.

"But I expect the government to peg the (2006/07) fiscal deficit at 4 per cent of GDP."

India's economy is expected to expand by 8.1 per cent in the year ending March 31 and buoyant revenues could help Chidambaram meet this year's fiscal deficit target of 4.3 per cent of gross domestic product.

Analysts expect the government to aim for a fiscal gap of around 4 per cent of GDP next financial year. A 0.3 percentage point reduction would be in line with India's law on fiscal responsibility.

"The finance minister may announce a deficit target of about 4 per cent of GDP, but spending pressures will mean that achieving such a target will be quite a challenge in fiscal 06/07," said Siddharth Mathur at JP Morgan Chase, Mumbai.

First Published: Feb 17, 2006 15:40 IST