Bonds rise on "challenging" fiscal deficit target

By Swati Bhat

MUMBAI (Reuters) - Bonds rose to one-week highs on Thursday while the rupee also gained after new Finance Minister Arun Jaitley stuck to the fiscal deficit target of 4.1 percent of gross domestic product for this fiscal year set by the previous government.

The government also revised up market borrowing to a gross 6 trillion rupees ($100.42 billion) from 5.97 trillion rupees in the interim budget, well within analysts' expectations.

The promise of fiscal discipline was welcomed by investors, although the government will need to reassure markets it can meet its ambitious projections for revenue and spending.

"The intention to retain the fiscal deficit at 4.1 percent is a big positive for the bond markets, although it looks challenging to meet, especially with a large increase in non-tax revenues," said Arvind Chari, head of fixed income and alternatives at Quantum Advisors.

The benchmark 10-year bond yield fell as much as 7 basis points from pre-budget levels to 8.64 percent, its lowest since July 3. The yield had ended at 8.73 percent on Wednesday.

The partially convertible rupee strengthened to as high as 59.57 per dollar, its strongest since July 3, before easing to 59.82 in later trade. It had closed at 59.75/76 on Wednesday.

Jaitley projected a gradual reduction in the fiscal deficit to 3.6 percent and 3.0 percent of GDP in the next two fiscal years.

The government also raised the limit on foreign direct investment in defence and insurance ventures to 49 percent from 26 percent, which is expected to help the rupee in the medium to longer term.

The tight fiscal deficit targets are expected to help keep a lid on prices, a critical factor in a country where consumer price inflation was 8.28 percent in May, and could potentially allow the Reserve Bank of India some room to cut interest rates.

In the overnight indexed swap market, the benchmark 5-year swap rate dropped 6 bps from pre-budget levels to 7.80 percent while the 1-year rate fell 5 bps to 8.31 percent. The rates had closed at 7.87 percent and 8.37 percent respectively on Wednesday.

($1 = 59.7500 rupees)

(Reporting by Swati Bhat; Editing by Alan Raybould)