(Photo: Reuters)
(Photo: Reuters)

Opinion | Bond markets cheer, but it’s not an easy ride

Government securities are not expected to rally significantly going forward

As the lady rose to present the final Union budget for 2019-20, carrying documents not in a briefcase but in a red cloth with the national emblem and a ribbon, the nation looked forward to growth-enablers to propel the gross domestic product (GDP) to $5 trillion in five years. Well, there were vision and mission statements, and positive intent.

The equity market sulked, in spite of the growth push, what with buyback tax, proposal of minimum public holding of 35% which would impact promoter-dominated companies and higher tax surcharge on the “super-rich". The bond market cheered; the 10-year government securities (G-secs) yield, which rallied to an intra-day low of 6.61%, closed the day at 6.69%. The positives that drove the bond market are:

* Fiscal deficit target, something the bond market is obsessed with, was stated at 3.3% of the GDP, against 3.4% mentioned in the interim budget. The bond market was prepared for a minor slippage from 3.4% to, say, 3.5% or 3.6% of the GDP, hence 3.3% came as a positive surprise.

* This also helps the cause of policy rate easing by the Reserve Bank of India (RBI) because fiscal deficit is one of the factors considered by RBI for setting interest rates. The achievement of a deficit target of 3.3% is a challenge, but it at least shows positive intent to gradually reduce deficit.

* There is a proposal to issue government bonds abroad, in foreign currency. This has been taken positively because, to the extent, government borrowing goes abroad, fresh supply of papers in India would be lower.

* Foreign portfolio investors have been encouraged; the government would make know-your-customer (KYC) norms more investor-friendly to streamline the investment process.

However, there are challenges in achieving what is discussed above. The fiscal deficit target of 3.3% of the GDP is based on certain assumptions:

* Tax growth targets for 2019-20 are ambitious.

* The fiscal deficit percentage is based on a certain GDP growth assumptions. The given estimate of fiscal deficit, which is 7.04 trillion, assumes a certain GDP number to arrive at 3.3%, which, in turn, is based on a certain real GDP growth rate plus a certain inflation number. If GDP growth is lower, achievement of the target would be a challenge.

* Offshore borrowing has been proposed, which is logical in view of the large global pool of liquidity and negative interest rates in many parts of the world. However, execution is the key. When government bonds would be issued abroad, to what extent, at what rates etc. are all question marks. There is a foreign currency risk as well.

* The net government borrowing from the market in 2019-20 i.e. net of maturity repayments, through G-secs and Treasury Bills, is estimated at 4.48 trillion, which is similar to 4.47 trillion of 2018-19 revised estimates.

From this level onwards, G-secs are not expected to rally significantly as they have discounted policy rate easing by RBI’s monetary policy committee (MPC) going forward. Going by the parameter of the spread of the 10-year G-sec yield (6.69%) over RBI overnight repo rate, which currently is 5.75%, is little less than 1%. The long-term average of this parameter, over the last 10 years, is similar. That is to say, the 10-year G-sec yield has already reached the long-term average. Given this view, it is advisable for fixed-income investors to invest fresh money in funds or bonds with maturity on the lower side, say up to three or four years, so that volatility risk emanating from higher portfolio maturity is contained. For existing investments, stay put.

For people availing of loans from banks, rates are expected to ease gradually as:

* The MPC has reduced policy repo rate by 0.75% this calendar year and is expected to ease further going forward;

* Transmission of rate cuts to actual loan rates have been limited so far, but is expected to happen as RBI is infusing liquidity into the banking system;

* The Union budget proposes infusion of capital of 70,000 crore to public sector banks to boost credit growth;

* The budget proposes purchase of pooled assets of non-banking finance companies (NBFCs) by banks, up to 1 trillion with partial loss guarantee from the government for loss up to 10%. There was an announcement from RBI, post-budget in the afternoon, on certain relaxations on LCR for banks for incremental loans to NBFCs, amounting to 1.34 trillion.

Joydeep Sen is founder, wiseinvestor.in

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