The excitement of watching a Budget day speech for most market participants is still as exciting as celebrating one’s birthday. Depending on who is watching the budget, the points of adrenalin rush vary!
For the bond market participants too there is, among others, a single point watch – just like how Arjuna was focused on the bird’s eye in the Mahabharata. That single point watch for bond market participants was the fiscal deficit number as a percentage of India’s GDP. This number is significant because unlike many parts of Western world, India’s fiscal deficit is almost entirely captive funded. Also, this budget FY 2202 has been presented amidst the vaccine period or the year of Hope. Hence, the palpitation was understandable.
So what did the market make out of the budget numbers presented this time?
Budget FY22 has been a fairly realistic one on most counts. The thrust has been on capital expenditure which has seen an increase of 26% over FY 2021.
There has been an emphasis on infrastructure and the BFSI sector with a focus on healthcare too. While there is consciousness on being fiscally responsible over time, for FY 22 the total fiscal deficit has been pegged at 6.8% of GDP – signalling higher market borrowing to fund capex. Tax assumptions too have been quite modest (in line with nominal GDP growth) and can be considered positive as economic growth picks up.
While equity markets have relished this move, an added INR Rs 80,000 cr of government bond supply for FY 21 has spooked the bond yields (~15 bps uptick in bond yields). The gross borrowing for FY 22 is pegged at INR 12 lakh crore – which is higher than what markets expected. Hence yields have moved up across the curve especially mid to long end of the yield curve. Liquidity in the banking system still remains comfortable, hence overnight rates may continue to hug the reverse repos rate for now. The current yield curve is too steep enhancing the case to chase the carry in fixed income as opposed to capital gains.
All eyes are now on RBI’s MPC to indicate a way forward. With comfort in inflation, reduction in gold imports, stable-to-appreciating INR, we think it is too premature to remove accommodation bias on interest rates. We do expect a status quo, hence a long pause may continue. Key to watch is some indication on OMO continuity – a necessary ingredient if long end yields need to remain in check. For now, the additional borrowing of INR Rs 80,000 cr is certainly an unanticipated one and with poor appetite, it is difficult to see passage of the auctions without uptick in yield. For investors, it is best to stick to intended investment horizons as volatility would continue to be order of the day.
(Lakshmi Iyer, CIO – Debt & Head – Products, Kotak Mahindra Asset Management Company. Views expressed are the author’s own.)