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MUMBAI- The Indian government's borrowing will likely hit a record high next fiscal year, as it prioritises growth, which could push bond yields higher, ICICI Bank's treasury head told Reuters on Thursday.

The government will likely borrow 15.75 trillion rupees ($193 billion) in the fiscal year starting April, targeting a fiscal deficit of 5.9% of gross domestic product, said B Prasanna, global head–global markets–sales, trading and research at ICICI Bank.

That is higher than the 14.21 trillion the government is set to borrow in the current financial year ending March, to fund a fiscal deficit of 6.4% of GDP.

"The government is already indulging in capital expenditure and is cognizant of kick-starting growth," said Prasanna.

"If there is a situation where there is an increase in the government's tax collections, they would want to use it for higher expenditure and not want to give that benefit to the market by borrowing less."

India's federal budget is due on Feb. 1.

Prasanna expects the 10-year benchmark bond yield to stay in the 7.25%-7.50% band over the next few months, compared with 7.29% currently, but cautioned of a rise once the government starts borrowing for the next financial year.

The 7.26% 2032 bond yield hit a high of 7.62% in June last year.

"The yield can cross 7.50% only if the government comes up with a substantially high borrowing number or if the timetable and the choice of papers for the auctions are not well calibrated as per market expectations," Prasanna said.

POSITIVE SURPRISES

Prasanna, though, said bond yields could drop due to various factors, including if Indian bonds are included in a global index or if the Reserve Bank of India (RBI) resumed bond purchases, which it stopped in October 2021.

"If the bond index inclusion happens, we will get about $15-20 billion of inflows and that can make the demand situation much rosier."

"The other factor is the possibility of the RBI opting for open market purchases at some point in FY24 if liquidity keeps getting sucked out."

The markets are waiting for clarity on the likelihood of Indian bonds being included in global indices this year.

GRAPHIC : India 10-year bond yield movement - https://www.reuters.com/graphics/INDIA-MARKETS/lbpggookjpq/chart.png

PEAK RATE TO STAY

Prasanna expects the RBI to raise interest rates next month and did not rule out further increases, which, he said, may depend on how much the U.S. Federal Reserve hikes rates.

The Fed has raised rates by 425 basis points in 2022, to the 4.25%-4.50% band, while the RBI hiked by 225 bps to 6.25%.

"The base case is that (India's) terminal repo rate will peak at 6.50%. However, we are not ruling out a move to 6.75%. The RBI will have to maintain an interest rate differential of at least 1.50%. Our base case is that the Fed will pause at 5%."

Prasanna said even if the Fed cuts rates later this year due to recession fears, the RBI will not follow suit immediately.

"The repo rate at 6.50% is not high compared to historical Indian standards, and hence the RBI may not be in a hurry to cut rates, and we may be near peak for the next 12 to 15 months."

(This story has been refiled to correct the graphic to represent bond yields in percentage) ($1 = 81.6450 Indian rupees)