Why in the News?

Government borrowing costs are rising even after successive repo rate cuts by the Reserve Bank of India (RBI). Since February 2025, the RBI has reduced the repo rate by 100 basis points from 6.5% to 5.5%. However, yields on 10-year government securities have increased from 6.66% to 6.73% during the same period.

This divergence is significant because bond yields typically soften after rate cuts. Instead, governments are now paying 0.4-0.5 percentage points more to borrow compared to 10-15 years ago. The issue affects both the Centre and States, which together budgeted gross market borrowings exceeding ₹40 lakh crore in 2025-26. Rising yields increase interest burdens and crowd out developmental expenditure.

Why Are Borrowing Costs Rising Despite Repo Rate Cuts?

1. Limited Monetary Transmission: Repo rate reduced from 6.5% to 5.5% since February 2025. 10-year G-sec yields increased from 6.66% to 6.73% during the same period.
2. Higher Risk Premium: Markets demand higher yields due to elevated debt levels and fiscal pressures.
3. Liquidity Tightening: RBI reduced bond purchases and ended aggressive liquidity injections.
4. Foreign Outflows: Net FPI outflows of $12.5 billion during April-September 2025 reduced bond demand.

How Large Is the Government Borrowing Programme?

1. Gross Borrowing (Centre): ₹14.90 lakh crore budgeted for 2025-26.
2. Gross Borrowing (States): ₹18.14 lakh crore budgeted.
3. Combined Gross Borrowing: Exceeds ₹40 lakh crore.
4. Net Borrowing (Centre): ₹11.73 lakh crore in 2025-26.
5. Net Borrowing (States): ₹10.75 lakh crore in 2024-25.

What Is the Status of Outstanding Liabilities?

1. Centre’s Liabilities: Increased from 48.1% of GDP (2015-16) to above 55% in 2025-26.
2. States’ Liabilities: Increased from 22.3% (2015-16) to 29.2% in 2025-26.
3. Combined Liabilities: Exceed 80% of GDP.
4. Interest Burden: Governments now pay 0.4-0.5 percentage points more compared to 10-15 years ago.

What Role Has Liquidity Played?

1. Pandemic Liquidity Surge: RBI expanded liquidity during 2020-22 to manage economic slowdown.
2. Subsequent Tightening: RBI reversed bond purchases and injected limited liquidity.
3. Foreign Exchange Dynamics: RBI sold dollars to stabilize the rupee, reducing domestic liquidity.
4. Capital Inflows: Net foreign capital inflows modest at $18 billion during April-September 2025.

How Does This Affect Fiscal Management?

1. Higher Interest Payments: Expands revenue expenditure commitments.
2. Reduced Fiscal Space: Limits developmental and capital spending.
3. Crowding-Out Effect: High government borrowing absorbs financial resources.
4. State-Level Stress: States face similar yield pressures amid large borrowing programmes.

Conclusion

Rising borrowing costs despite repo rate cuts indicate structural stress in India’s fiscal and financial architecture. Elevated debt levels, reduced liquidity support, and weak monetary transmission have increased the interest burden on both the Centre and States.

Sustained high yields risk expanding revenue expenditure, compressing capital spending, and constraining developmental priorities. The situation underscores the need for calibrated fiscal consolidation, improved debt management, and better coordination between monetary and fiscal policy to ensure macroeconomic stability without compromising growth.

PYQ Relevance

[UPSC 2019] The public expenditure management is a challenge to the Government of India in context of budget making during the post liberalization period. Clarify it.

Linkage: The question examines fiscal discipline, debt sustainability, and expenditure prioritisation under the post-liberalisation framework. The article highlights rising borrowing costs and elevated liabilities, which intensify interest burdens and constrain public expenditure management, making budget balancing more complex.

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