Bond dealers and economists give thumbs down to 'inflationary' Budget

Bond dealers are reckoning on at least one rate hike in the second half of the next financial year

Bond dealers and economists have interpreted the Budget this year as inflationary, describing the government’s numbers are aggressive.

Also, there is a high chance that the markets are staring at another year of fiscal slippage.

This will have a direct impact on the Reserve Bank of India’s (RBI’s) monetary policy and it will likely have to abandon its cautious, “neutral” stance in favour of a hawkish tone, economists say. And there may be a sooner than expected rate hike. Starting February 7 monetary policy, the tone of the policy could start turning hawkish.

“This Budget seems to be inflationary. All customs duties have gone up because the government is targeting the revenue side. Besides, measures like minimum support price (MSP) hikes will increase food prices,” said Indranil Pan, chief economist, IDFC Bank.

The consensus in the market was that the RBI would not hike rates in this calendar year, but that is now challenged. Bond dealers are reckoning on at least one rate hike in the second half of the next fiscal year, or even before that.

“There is now an increased probability that we are moving towards a tightening stance. Any expectation of rate cuts is now eliminated,” said Pan.

Finance Minister Arun Jaitley in his Budget said the fiscal deficit had slipped to 3.5 per cent of gross domestic product (GDP) in the current fiscal year from 3.2 per cent estimated earlier, while at the same time, he expected the fiscal deficit to remain 3.3 per cent for the next fiscal year.

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The bond market, unsurprisingly, reacted to these announcements sharply. The yields on the 10-year bond jumped to 7.612 per cent, the highest since March 14, 2016, after the Budget announcement. The yields closed at 7.60 against its Wednesday’s close of 7.43 per cent. This is despite the net borrowing at Rs 4.62 trillion for the next fiscal year, lower than market expectations. Gross borrowing comes to Rs 6.06 trillion. 

“The yields have risen sharply because of this inflation risk and also there is no appetite for this large borrowing. Investors are sitting out and nobody knows when they would be back. The incremental space for foreign portfolio investment in debt is limited as of now,” said A Prasanna, chief economist, ICICI Securities Primary Dealership Ltd.  

The market is also upset the government is planning to keep the net 91-day Treasury bill outstanding at a steep Rs 1.08 trillion, against Rs 20.02 billion this year. 

“About Rs 1 trillion worth of bonds issued under the market stabilisation scheme (MSS) is maturing in March, but the outstanding amount of 91-day T-bill shows that the government is not interested in putting back liquidity in the system. This is a huge dampener for the liquidity scene and yields have responded accordingly,” said a senior bond dealer with a foreign bank. 

The government’s aim to raise the minimum support prices (MSP) for all crops to 1.5 times of production cost will likely increase food inflation and thereby the headline retail inflation numbers. This will put enormous pressure on the Reserve Bank of India (RBI) to maintain its inflation focus.

“There is a risk of inflation going up and the RBI abandoning its neutral stance, but it remains to be seen how the MSP hike is implemented,” said Prasanna.  

Besides, the government’s budgetary math was ambitious for the next year at a time when the current fiscal year saw significant slippages. For example, the revenue deficit budgeted in the current fiscal year was at Rs 3.21 trillion, but came at Rs 4.39 trillion.

“Investors’ confidence will remain challenging, given so much of reliance on divestment, other capital receipts etc. and the recent incident of extra borrowings. Moreover, a policy-driven rise in corporate bond will also have substitution effects,” said Soumyajit Niyogi, associate director at India Ratings and Research.

Corporate bond markets may deepen
 
In a move that could make the corporate bond market deep, the Budget for 2018-19 proposed that the regulatory bar to invest in corporate bond paper would be A, instead of AA, while also mandating large corporates to raise one-fourth of their funding through bonds.
 
There is an RBI-mandated limit on how much exposure a bank can take in a company. By April 2019, this limit should be Rs 100 billion, beyond which the banks will have incur higher provisioning and the company thereby will have to borrow at higher cost.
 
Since the RBI and Sebi rules are always in sync, the government could be realigning the rules, said Shameek Ray, head of debt capital market, ICICI Securities Primary Dealership Ltd. However, the biggest change will come in the form of lowering the rating requirements for investment. Resource mobilisation through issuing corporate bonds in 2017-18 till November was at Rs 4.23 trillion, most of it through private placement, according to the Economic Survey.
 
Market observers say more than half of the issuances come from firms rated BBB and below, while A-rated companies account for about 20 per cent of the issuance. The rest are papers rated AA and above.

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