Kuala Lumpur: India’s plan to pump $32 billion into state-controlled lenders to revive growth may spur a sovereign bond selloff on expectations of a widening fiscal deficit, analysts said.

The proposal will help stem a five-year cycle of bad loans and remove the banking system’s drag on growth, though the question is whether the government will have to raise spending further, Morgan Stanley said. PhillipCapital said the infusion may inflate the fiscal deficit and push up yields.

“The recapitalization plan will impose upward pressure on long-term Indian government bond yields, while propping up economic growth and the rupee in the medium–to long-term," Scotiabank strategist Qi Gao wrote in a note.

The record capital injection and plans to spend on building roads is Prime Minister Narendra Modi’s latest attempt to revive an economy that’s expanding at its slowest pace in three years. The concern is that the government will have to sell even more debt to fund its spending, with the central bank warning earlier this month of possible “fiscal slippages."

The yield on sovereign notes due in a decade ended two basis points down at 6.78% Tuesday after economic affairs secretary S. C. Garg sought to reassure markets by saying said the government is working to achieve the fiscal deficit target of 3.2% of gross domestic product for the fiscal year. The rupee closed down 0.1% at 65.0675 per dollar.

Bonds are heading for a third consecutive month of losses.

Under the plan announced late Tuesday, the government will sell Rs1.35 trillion of recapitalization bonds while banks will raise another Rs76,000 billion through “budgetary support" and from the markets. The government also announced plans to spend $108 billion on building highways in the next five years.

“The risk of fiscal slippages arising directly from this channel is low, though we do not completely rule out the possibility, especially if the government were to raise its spending further," Morgan Stanley economists including Derrick Kam wrote in a report. Bloomberg

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