The beneficiaries of RBI's repo rate cut are typically corporate and individual borrowers, but this time around the move is aimed at easing the pressure on the government which has dramatically increased its borrowing target to deal with coronavirus impact on economy.

The surprise repo rate cut today by the Reserve Bank of India (RBI) has baffled many in the market. RBI Governor Shaktikanta Das today announced a 40 basis points rate cut to 4 per cent. This is the second rate cut announcement amid coronavirus lockdown. The rate cut would certainly ease the pressure on retail as well as corporate borrowers. But it will also help the RBI as a debt manager of the government to handle the huge government borrowing programme which is coming up in the next ten months of FY21.

The government has already prepared a plan to raise Rs 12 lakh crore in 2020-21, which was revised by a staggering Rs 4.2 lakh crore few weeks back to take care of revenue losses and the economic stimulus announced by Finance Minister Nirmala Sitharaman. But a high government borrowing programme throws up multiple challenges for the government and the RBI.

First, there are limited savings in the market to invest in government securities. The market can absorb something like Rs 14-15 lakh crore as 7 per cent of net financial savings of the GDP.  The corporate sector, which is coming out of debt over leveraging, doesn't have much savings to invest in wake of coronavirus impact. But now with centre and states borrowing over Rs 22 lakh crore, there will be excess supply of paper, which will push up yields. At the same time, the RBI has to ensure that both centre and states borrow at a lower rate.

Second, the higher government borrowings will increase the outstanding stock of government debt, which is unavoidable in such difficult times. The government has tried to keep deficit financing at minimum despite demand for higher stimulus from economists, states, opposition parties and global experts. The central government's gross borrowing figure may or may not increase by the end of March 2021 - that'll depend upon the the full impact of Covid and the ongoing lockdown. In addition, the gross borrowing of states which was initially estimated to be at Rs 6.41 lakh crore in 2020-21 has now been enhanced to Rs 10.69 lakh crore.

Thirdly, the RBI plays a critical role in yield management or interest rate management. Two years ago, the yield in government securities shot up, which forced RBI to take several measures to calm the market.Currently, the 10 year G-sec yield are at slightly less than 6.0 per cent. So far, there is no indication of debt monetisation (printing of notes by RBI to fund government borrowings) by the government. This means that the government will borrow directly from the market. As a result, the RBI will have the most challenging task at hand to manage the yields. Higher supply of debt will depress the G-sec prices and shoot up yields.

Yield management in the current juncture will require work on multiple fronts by the RBI. The repo rate cut is one of the tool to reduce the overall interest rates in the economy. In addition, the RBI has infused additional liquidity which ultimately helps in softening of interest rates. RBI is also buying longer tenor government securities and selling shorter tenor paper to manage the yield on the longer term securities. The market calls it operation twist.

Going forward, there are expectations that the RBI will hike the held to maturity (HTM) bucket, which helps banks to buy government securities eligible for SLR without attracting any  mark-to-market losses. In a current scenario of over supply of G-sec paper and a likely fiscal deficit slippage of over 5-6 per cent in future, the yield could go up, which means G-sec prices will fall. The repo rate cut is certainly one measure to help the government get funds at a cheaper rate, but the RBI will have to follow up with many other measures in the months to come.