Will govt meet its fiscal deficit target? Bond traders are too skeptical

Most Indian traders are acting like the best days of the bond market are behind it as they wait for the government to blow out the budget.

But Jayesh Mehta, a veteran trader at Bank of America Merrill Lynch is a rare bull in Mumbai’s fixed-income world. He thinks fresh gains are just around the corner.

Sovereign debt sold off in the past two months on fears Prime Minister Narendra Modi will expand the record Rs 7.1 trillion ($100 billion) in borrowings to support a slowing economy. The rout diminished the impact of Asia’s most aggressive monetary-policy easing and a banking system that’s flushed with liquidity.

“Bond traders are pricing in fiscal slippage and higher borrowings,” but “our view is that the government will meet its deficit targets,” said Mehta, BofAML’s country treasurer. ‘Right now, market is skeptical but I reckon it will eventually change and see the 10-year yield dip below 6 per cent by end of March.”

Bonds will benefit from as much as 75 basis points of rate cuts, ample liquidity in the banking system and a clarification from the government on extra borrowings, according to Mehta.

I am “bullish on bonds,” he said, adding the RBI will focus on supporting growth even if inflation inches higher.

For Mehta, the 30-year bond veteran, going against the crowd and winning has become the norm. Early this year he correctly predicted the central bank would ease; he got the call right in 2017, too. Last August, he forecast a drop in yields.

Debt Support
 

His forecast now for yields to drop below 6 per cent compares with a consensus forecast of 6.45 per cent by end of the fiscal year in March. And his estimate of as much as 75 basis points of RBI rate reductions is more aggressive than the median for 25 points in a Bloomberg survey.

Mehta is also predicting the central bank can take a leaf from the Federal Reserve and the European Central bank and start monetizing the government deficit by buying bonds to support the economy and keep a lid on yields.

The central bank could do bond purchases worth $15 billion in the next six months, according to estimates of BofAML’s India economists. The central bank in August already approved a record Rs 1.76 trillion ($24.4 billion) payout to the government.

“The central bank can monetize the fiscal deficit by buying bonds,” said Mehta. “The U.S. Fed and other Central banks are doing it, so it’s likely the RBI may also do the same.”