India Budget set to take borrowing to record levels, testing bond yields

Indian traders are bracing for a year of record government debt supply, which could keep borrowing costs high in the country’s $1.3 trillion bond market.Finance Minister Nirmala Sitharaman’s Feb. 1 budget could raise gross debt 11% to 16.5 trillion rupees ($180 billion) for the fiscal year starting April 1, according to the average estimate of 21 economists in a Bloomberg survey.

The increase, driven by large debt maturities of around Rs 5.5 trillion, comes as large government bonds push up yields. Higher borrowing costs threaten to increase pressure on the economy, which is facing high US rates, while the central bank has little room to cut rates further to stimulate growth.

According to the poll, net debt, excluding repayments, will be slightly higher at Rs 11.6 trillion. Although economists expect a smaller budget deficit of 4.2% of gross domestic product next year, that may not be enough to ease pressure on bonds as high supply exceeds demand.

“Disciplined central government fiscal policy is necessary but not sufficient to ease bond market tensions,” Dhiraj Nim and Sanjay Mathur, Australia and New Zealand Banking Group economists, wrote in a note. “More support from central banks will be needed to prevent an excessive increase in borrowing costs.”

The Reserve Bank of India has ramped up bond purchases to inject liquidity into the banking system, with yields still close to levels before 125 basis points of rate cuts. It announced a new round of injections worth $23.6 billion in the coming weeks to ease tight cash conditions. Still, the Bloomberg poll shows that the benchmark yield will remain around the current level of 6.7% at the end of 2026.

Government borrowing, which has risen to a record as they boost social spending to win elections, is putting pressure on yields. It comes at a time when demand from key investors has weakened, with pension funds shifting to equities and slower premium growth curbing purchases by insurers. IDFC First Bank Ltd. expects provinces’ gross borrowings to rise 7% to 13 trillion rupees in the next fiscal year.

Some fund managers, including ICICI Prudential Asset Management Co., expect domestic demand for bonds to pick up in the coming year.

“Fears surrounding supply demand may be exaggerated,” the report said. “Major sources of demand such as banks, pensions and insurance have the ability and willingness to add government and government bonds to their balance sheets.”

However, others still expect a shortfall in demand, forcing the RBI to intervene again. DBS Bank Ltd. expects the central bank to buy 3 to 4 trillion rupees of bonds in the coming year, while Nomura Holdings Inc. expected purchases of around 2.5 trillion rupees.

“The RBI will have to buy government bonds” to add sustainable rupee liquidity to the banking system to help absorb the surge in supply, said Sameer Karyatt, head of trading at DBS Bank India.