Budget is mildly bearish for the bond market

The outcome of the budget has been more or less on expected lines. The fiscal deficit target for financial year 2019-20 is 3.8% of the GDP, up from the earlier estimate of 3.3%, and that for FY21 has been estimated at 3.5% of GDP. Though there is a fiscal slippage here, the bond market had more or less pencilled in a deficit of something around these numbers. The Fiscal Responsibility and Budget Management Act (FRBM) mandates a lower deficit and, in that sense, this is a deviation. Section, 4(2) of FRBM, popularly referred to as the “escape clause”, says that there is “a mechanism for deviation from the estimated fiscal deficit on account of structural reforms in the economy with unanticipated fiscal implications”. Apparently, there is no big-bang structural reform announced in this budget. However, a host of structural reforms have been ushered over the past few years, such as demonetization, GST and Rera. Purists will debate the justification of the deviation from FRBM targets, but the fact that the Centre’s finances are under constraint is known.

Now comes the context of borrowing from the bond market, since most of the deficit is financed by the issuance of bonds. The net market borrowing, net of repayments on maturity, has been estimated at ₹4.99 trillion for this financial year, against ₹4.73 trillion estimated earlier. This much incremental borrowing will be absorbed by the market, without much ado. For FY21, the net market borrowing is estimated at ₹5.4 trillion. But the issue is how credible are the numbers declared by the government.

There are two aspects here. One, the declared numbers. This is based on the assumption of a certain nominal GDP growth rate, as 3.8% or 3.5% of the headline GDP. And the deficit itself is subject to receipts being achieved. Tax collection growth rate has been tardy, what with growth itself being a challenge. The divestment targets of ₹2.1 trillion (PSUs) and ₹1.3 trillion (telecom) for FY21 are steep. Hence, the issue from the bond perspective is the potential for further slippage in FY21, from the estimated 3.5%. Two, the undeclared numbers. It is colloquially referred to as “off balance sheet” expenditure or the expenses not forming part of the budget per se. For example, higher borrowings of public sector units (PSUs) or issuance of bonds by certain PSUs serviced by the central government, or unpaid dues to certain PSUs.

There are certain other announcements from the fixed-income market perspective. The insurance on deposits in banks, which is currently ₹1 lakh per depositor per bank, is proposed to be increased to ₹5 lakh. This is good for the safety of depositors’ money, but this is applicable when the bank goes into liquidation.

The limit for investment by FPIs in corporate bonds is being increased from 9% of outstanding stock to 15%. Though, directionally, this is positive, as it shows that we are inviting foreign capital, it will not make a material difference. The quantum utilized, in terms of the FPI investment as a percentage of corporate bonds, is currently less than 60%. A government bond ETF has been announced, on the lines of the Bharat Bond ETF, which will be another means for reaching out to the public for resources.

To take a view on interest rate movement, the next Reserve Bank of India (RBI) monetary policy review is scheduled for 6 February 2020. Inflation is apparently a concern, CPI having shot up to 7.35% on high food prices. However, inflation is likely to ease as rabi plantation has been buoyant. The enhanced fiscal deficit may be a cause for concern for RBI as higher deficit may potentially fuel inflation. To conclude, this Budget is mildly bearish for the bond market, due to the lack of credibility of the deficit targets.

Joydeep Sen is founder, wiseinvestor.in