MUMBAI (Reuters) - The government needs to limit borrowing in the coming fiscal year to 6 trillion rupees ($87.85 billion) or risk sparking a bond market sell-off that could raise companies' financing costs and add to doubts about the strength of the economy, traders said.
With public debt already around 68 percent to gross domestic product (GDP), traders are wary of the government selling even more debt to finance its spending when it unveils its 2016/17 budget on Feb. 29.
Markets not only expect the government to show fiscal responsibility, but also to spread out the sale of longer tenor debt after an uneven pace of sales last year put pressure on prices. India's fiscal year starts on April 1.
Traders said higher borrowing could easily send the new benchmark 10-year bond yields up to 8 percent, from 7.73 percent now -- a risk to the economy given the debt is used as a benchmark for a wide range of borrowers, including companies and states.
"The risk of bond yields shooting up is real if the government exceeds its self-imposed fiscal deficit targets," said A. Prasanna, an economist at ICICI Securities Primary Dealership Ltd in Mumbai.
Although the Reserve Bank of India cut its repo rate by a total of 125 basis points last year, 10-year bond yields, particularly the old 10-year bonds, remain at similar levels to a year ago.
Analysts said longer-end bonds have failed to rally much because of the government's strategy of selling debt with longer-maturities to push out redemptions to later years.
Sales of bonds with maturities of 15 years or more rose to nearly 2 trillion rupees from April to December alone last year, a 17 percent jump from a year ago.
That is raising the focus on this year's budget. A Reuters poll last month showed analysts expect India to slightly raise its fiscal deficit targets to increase capital investments and boost an economy growing slower than the government's target.
A mild increase could be acceptable as long as the government avoids cranking up bond sales and spreads out the sale of longer tenors, traders say. The government has borrowed an average of 5.8 trillion rupees in the previous three years.
At the same time, traders are on edge about how much debt individual states will sell next year as they are pushed to absorb 4.3 trillion rupees in debt held by their utilities.
RBI Governor Raghuram Rajan warned last month of the risks the budget posed to bond markets.
"Deviating from the fiscal consolidation path could push up government bond yields, both because of the greater volume of bonds to be financed and because of the potential loss of government credibility on future consolidation," Rajan said.
India's economy grew an annual 7.3 percent in the October-December quarter, although many economists say official data overstate the economy's strength. They point to weak exports, railway freight, cement production, investment and flat order books as evidence of weakness.
($1 = 68.2995 Indian rupees)
Editing by Rafael Nam; Editing by Kim Coghill