(Bloomberg)
(Bloomberg)

Bond yields rise follow tax gifts, cash transfers announced in interim budget

  • An announcement of record borrowing plan at Rs. 7.04 trillion for fiscal year 2020
  • Analysts cautioned against rising risk to the fiscal consolidation efforts from higher expenditure outlay in the budget

India's 10-year government bond yield rose nearly 10 basis points on Friday as analyst expected government to face challenges in meeting its target for fiscal year 2020 after interim finance minister Piyush Goyal announced tax gift for middle class and cash transfer for farmers ahead of final elections due in May.

An announcement of record borrowing plan at 7.04 trillion for fiscal year 2020, higher than 6.4 trillion according to Bloomberg estimates, to meet the expenditure targets weighed on bond yields.

The Interim Budget 2019 has not increased the basic exemption limit from 2.50 lakh, it has increased tax rebate under Section 87A from 2,500 to 12,500 and would cover taxpayers having taxable income up to 5, 00,000.

To woo the farmers ahead of general elections, the government announced a scheme under which farmers with up to 2 hectares will get direct income support of 6,000 per year. The amount will be transferred directly into bank accounts of farmers in three installments. Around 12 crore farmers are estimated to benefit from this scheme, finance minister said.

Analysts cautioned against rising risk to the fiscal consolidation efforts from higher expenditure outlay in the budget.

"No new policies to increase revenues were announced, while a number of expenditure measures were announced that will increase outlays and put pressure on the government’s ability to meet its fiscal deficit target", said Moody's Investors Service in a note. "Ongoing slippage from the government’s budgeted fiscal deficit targets over the past two years, and our expectation that the government will face challenges meeting its target again this coming fiscal year (ending March 2020) does not bode well for medium term fiscal consolidation. We view this continued slippage as credit negative for the sovereign", Moody's Investors added.

The government has already breached the fiscal deficit target for FY19 which was at 3.4% of gross domestic product from 3.3% budgeted estimate last year.

While spending on rural sector and tax cuts for the middle class will boost consumption, analysts warn that it will crowd out private investments.

"Overall, the government presented an expansionary budget and prioritized populism over fiscal prudence (i.e., this is an election budget). The deviation from the FY19 fiscal deficit target and the “pause" on FY20 fiscal consolidation is a negative surprise, relative to our expectations. The cumulative effect of the cash transfer to farmers and the middle income class will be a boost to consumption, but likely at the cost of crowding out private investments. This growth mix generally tends to be a negative for macro imbalances", said Nomura Research in a note.

All eyes are on the RBI policy next week to see if the central bank cuts rates or maintains status quo following pro-growth budget.

"We expect the Reserve Bank of India (RBI) to view the budget as inflationary and flag this as an upside risk to inflation. The expansionary fiscal impulse, at the margin, negates the need for the Reserve Bank of India (RBI) to consider monetary easing at this stage. At the 7 February policy meeting, we expect the monetary policy committee to vote 5-1 to keep the repo rate unchanged. However, we expect the stance to change to ‘neutral’ from ‘calibrated tightening’, reflecting balanced growth/inflation risks", Nomura report added.

At 2.51pm, 10-year bond yield was trading at 7.375% from its Thursday's close of 7.283%. Bond yields and prices move in opposite directions. The rupee was trading at 71.34 a dollar, down 0.35% from its previous close of 71.09. The home currency opened at 71.07 a dollar.

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