A poor monsoon threatens to worsen India's already steep fiscal deficit as it spends on food imports and relief for farmers, although the government is seen tapping the bond market only as a last resort to fund any further shortfall. With investors already forced to absorb a record 4.51 trillion rupees ($93 billion) billion in borrowing this year.
New Delhi is expected to look elsewhere for funds to plug the growing budget gap, including the sale of third-generation mobile spectrum and stakes in state companies. The government could also cut spending. "Probably they need to borrow more but there is no appetite. So it is kind of a deadlock situation," said J. Moses Harding, head of the global markets group at IndusInd Bank in Mumbai.
Drought relief could push up India's fiscal deficit by as much as $4 billion, or 0.5 percentage points, economists say. Already, the government expects a fiscal deficit of 6.8 percent of GDP for the year ending in March - its highest in 16 years.
Worries about looming inflation have curbed demand for longer-dated bonds, forcing the government this month to unveil a shorter-term notes programme to manage liquidity. "It is very clear the demand side market is saturated," said Arvind Sampath, head of interest rates trading at Standard Chartered in Mumbai.
"They will find other sources such as 3G to finance those but not stretch the bond market anymore," he said. Including state-level shortfalls, India's total fiscal deficit may hit double-digits as a percentage of GDP this year.
On Thursday, the central government gave states permission to borrow an additional $4.3 billion in the current year. Rainfall was 26 percent below normal in the June-September monsoon season through August 19, threatening crops including rice and sugar and sending food prices higher, even as overall inflation remains muted given last year's high base effect on record oil prices.
Food subsidies, meanwhile, are rising. Farm Minister Sharad Pawar said they would top 600 billion rupees ($12.3 billion) this year, about 15 percent higher than was estimated last month. In 2002/03, the last major drought year, the federal government's fiscal deficit came in at 5.9 percent of GDP, higher than the budget estimate of 5.3 percent.
Agriculture's share of the overall economy, however, has decreased to about 17 percent from 21 percent during the last bad drought year. Benchmark 10-year government bond yields are already at nine-month highs on worries about heavy supplies after a poorly received auction last week. But traders are not yet worried that drought relief measures will translate to increased issuance.
Finance Secretary Ashok Chawla said last week there was no need to borrow beyond the amount already targeted, and said adjustments to spending would be made from the existing budget. If rain this season is so poor that the winter sowing season is also threatened, however, pressure could build for the government to step up spending on measures such as subsidised imports and rural welfare programmes.
Elections later this year in a handful of states raise the stakes for the ruling Congress-led coalition to deliver for its key rural constituency. "I think there will be a modest deterioration and it will probably be thanks to expenditure spillover, particularly food subsidy," said Atsi Sheth, chief economist at Reliance Equities.
Economists say a drought could curb growth this year by as much as 2 percentage points. The central bank and finance ministry expect growth of 6 percent or more, compared with 6.7 percent last year after three years averaging 9.4 percent. India's fiscal deficit, meanwhile, appears poised to remain stubbornly high.
Abheek Barua, chief economist at HDFC Bank in New Delhi, said he expects the weak monsoon to drive the fiscal deficit to 7.1 to 7.3 percent of GDP this year, with a possible spillover into the following year. "I think what we are getting sort of trapped in is a situation of persistently high deficits," he said.
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