India’s bond market doesn’t seem to like it one bit that companies have been given a tax relief. The benchmark 10-year government bond yield surged by over 20 basis points after the government announced companies get to keep more of their profits with a corporate tax cut.

Since effective tax rate for companies would be lower now and even lower for firms born October onwards, the revenue that the government is forgoing is significant. Finance Minister Nirmala Sitharaman puts the revenue foregone at 1.43 trillion or roughly 0.7% of gross domestic product (GDP).

Tax revenues were already stretched with goods and services tax (GST) collections under pressure. With the revenue foregone, analysts estimate that the fiscal deficit for FY20 would be as high as 4.0% than the budgeted 3.3% of GDP. “Our estimate is that fiscal deficit could be 3.8-4.0% of GDP. Of course, we will have to see whether the government curtails spending or even steps up its disinvestment plan," said A. Prasanna, head of research at ICICI Securities Primary Dealership.

The immediate concern is that this fiscal slippage would mean the RBI would be less inclined to cut rates when its monetary policy committee (MPC) meets next month to decide on policy rates.

That said, bond traders would take comfort from the fact that headline retail inflation is expected to remain below 4% target for the next one year and economic growth has dropped to 5% in the June quarter. This in itself is a strong motivation to drop policy rates. Governor Shaktikanta Das had reiterated on Thursday that given the growth slowdown and low inflation, there is still room for rate cuts. “Despite possible fiscal slippage, the RBI would likely deliver further cuts and continue to focus on policy transmission of earlier cuts," said Madhavi Arora, economist, forex and rates, Edelweiss Securities in a note.

But, fiscal slippage cannot be ignored as it has implications on the government’s market borrowing. With the Centre’s income under pressure, borrowing more from the market is inevitable unless spending is curtailed.