India's Net Borrowings to Decline, Bolstering Bond Rally

India's net government borrowings are anticipated to decrease for a consecutive second year, potentially extending the rally in the country's bond market. This positive outlook stems from the government's adherence to its fiscal consolidation path.

According to a Bloomberg survey of 20 economists, Prime Minister Narendra Modi's administration plans to borrow 11.4 trillion rupees ($132 billion) in the fiscal year starting April 1, down from the current year's 11.6 trillion rupees. Gross borrowing, which encompasses repayments, may increase marginally to 14.7 trillion rupees.

Bond yields have declined to a three-year low after the central bank announced measures to inject $18 billion into the system. The 10-year bond yield has dropped by six basis points to 6.63%.

The borrowing announcement will be part of the federal budget presented on February 1. Notably, the financial system faces a cash squeeze, while foreign investors have been exiting Indian markets. Finance Minister Nirmala Sitharaman's mandate includes stimulating growth, maintaining fiscal discipline, and obtaining a sovereign ratings upgrade. Economists widely expect her to adhere to the roadmap of reducing the budget deficit to 4.5% of GDP in the next fiscal year.

"Fiscal consolidation will continue to lower the deficit to more sustainable levels and reduce the overall debt pile," said Pankaj Pathak, fixed-income fund manager at Quantum Asset Management Co. "This provides a favorable environment where bond supply is not expanding significantly while demand from long-term buyers is increasing."

While demand from insurance and pension funds sustains the market, a shift in incremental demand is notable. The central bank is emerging as a primary buyer of sovereign debt amidst waning demand from overseas funds. Secondary market purchases aim to mitigate a cash deficit that widened to its highest level in a decade last week.

Standard Chartered Plc and Citigroup Inc. estimate that the central bank may inject 1.5 trillion rupees and 2 trillion rupees, respectively, in the coming year. However, analysts suggest that additional liquidity infusion may be necessary before the end of the fiscal year in March.

Global uncertainty poses challenges to foreign inflows into India. JPMorgan Chase & Co.'s emerging market bond index will include India at its full 10% weighting by March, potentially reducing a key source of demand.

Despite these uncertainties, the 10-year yield is projected to decline to 6.50% by the year-end, indicating an easing of approximately 15 basis points from current levels.

"While gross Indian government bond issuance could modestly increase in FY26, the continued decline in net issuance is more significant," analysts at Morgan Stanley, including Upasana Chachra, wrote. "This should still allow government securities to rally over the medium term."