The bond market is once again facing a gigantic borrowing programme by the central government to fund economic revival.

In pandemic-hit 2020, yields strayed from fundamentals and drooped to decadal lows despite a record rise in government borrowing. The counterintuitive happened because of extraordinary easing moves by both, the Reserve Bank of India (RBI) and global central banks.

This year will be different, though.

One, economic recovery is gaining momentum. That implies a pick-up in credit growth. Banks will now have more options than the government to lend to, which could put some pressure on G-sec yields.

Two, the RBI will have to keep an eye peeled for inflation amid an expansionary fisc and rising input costs, though in general, inflationary pressures are expected to remain under control.

As of now, the RBI is not short on ammunition. But it may need to turn back the accommodative tap if inflation pressures rise. Some normalisation of liquidity has already begun.

Three, the RBI is also concerned about easy liquidity fuelling asset-price inflation and destabilising markets.

In other words, though the February 5 monetary policy review confirms the RBI’s intent to support the government’s borrowing programme next fiscal, maintaining such high levels of liquidity may no longer be easily possible.

We discuss the reasons for this here.