Mumbai, Feb 4 (PTI) With the Budget asking the Reserve Bank of India (RBI) to do a lot of heavy-lifting, a report has said that while managing higher market borrowings, the central bank should ensure that yields remain soft to ensure that it could raise banks' excess bond holdings by 4 per cent till 2025-26.

The Budget has pegged fiscal deficit at a much higher 6.8 per cent of GDP for 2021-22 when despite seeing growth at 11.5 per cent. According to analysts, the actual deficit will be 6.9 per cent, including the off-budget borrowings. For 2020-21, the fiscal gap is a record 9.5 per cent but including off-budget debt, it will be a steeper 10.5 per cent.

In the report, Bank of America Securities India Economists Indranil Sen Gupta and Aastha Gudwani said keeping the bond yields soft is the key for fiscal stimulus to work, given the heavy borrowing schedule for the next financial year 2021-22.

Already, since the Budget, the yields have been moving up, which if not contained will upset all RBI numbers.

To contain the bond yields, the report suggests that the RBI can hike HTM (held-to-maturity) limits by 4 per cent of the book till 2025-26 to incentivise banks to buy more government securities (G-Secs) without fearing MTM hits from 2022.

Another step that the central bank can do to arrest the rising yields is to step up the OMO (open market operations) calendar combined with two-three year reverse repos, at deposit rate-linked rates, to neutralise monetary impact.

A third measure that the RBI can do is to buy more forex forward to create space for higher OMO combined with two-three year reverse repos to support the G-sec market. Because the bottom line is that soft yields are the key for fiscal stimulus to work, they said.

Expecting the government to miss the divestment target of Rs 1.75 lakh crore, they peg fiscal deficit at 7.2 pr cent, leading to an excess G-sec supply of Rs 7,96,600 crore or USD 109 billion.

They also see the RBI forex interventions in 2021-22 at a whopping USD 45 billion.

We expect the RBI to hike banks' HTM limits by 4 per cent of the book (Rs 6,13,600 crore/ USD 84 billion) in 2021-22, atop the 2.5 per cent hike in 2020, to incentivise banks to invest their surplus money market liquidity in G-Sec auctions without fearing MTM limits from yields going up ahead.

"On balance, we expect the RBI to remain on hold through 2021-22 and hike rates 100 bps in 2022-23. We see a slim chance of a 25 bps (basis points) cut in the repo rate this time to reduce lending rates on SME, retail or mortgage loans linked to it," the house economists said.

While welcoming the Budget with a counter-cyclical fiscal policy to support recovery, they said its success hinges on the RBI's ability to fund the higher fiscal deficit at a soft risk-free that allows lending rate cuts.

In fact, we place the fiscal deficit at 7.2 per cent of GDP, assuming slippage in the disinvestment target. This translates into Rs 16,94,900 crore of net borrowing and excess G-Sec supply of Rs 7,99,600 crore.

The RBI is likely resort to higher OMOs combined with 2-3 year long-term reverse repos if banks hesitate to lock further funds in HTM, given the excess SLR of 10 per cent of book. In that case, it will directly bear the MTM risk. HRS hrs

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