Bond markets in a for a rocky ride

The Change

Caught between the devil and the deep blue sea, the Centre chose to up spending and slip on its fiscal deficit target, rather than stay the course on fiscal deficit. The Centre has achieved fiscal deficit of 3.5 per cent for FY18, against its budgeted 3.2 per cent. What is particularly worrying for bond markets is that the Centre has also chosen to offer itself some leeway in the next fiscal -- setting the fiscal deficit target to 3.3 per cent against 3 per cent earlier. The Finance Minister, not playing entirely by the book, is sure to upset bond markets. The yield on the 10-year G-Sec has inched up by 10 bps already.

The background

While the Centre seems to have more or less met its target for FY18 on the receipts front, it has overshot its expenditure target. From a budgeted growth of 6.5 per cent, expenditure is pegged to grow by 10 per cent in FY18. The miss on the fiscal deficit target has been mainly on this count. Direct tax has got a fillip from a higher than expected growth in corporate tax (from the budgeted 9 per cent to 14 per cent as per revised estimates), which is plausible if numbers until Nov 2017 are considered. The shortfall in non-tax revenues on account of lower dividend payout by the RBI has been offset by robust disinvestment proceeds. Hence, net-net, receipts are in line with expectations. But with the Centre having front-loaded its expenditure, there were expectations of expenditure shrinking by 8 per cent YoY in the last three quarters of the fiscal. On the contrary, the Centre has upped its spending, and taken a hit on fiscal deficit.

For FY19, the Centre has assumed a similar 16.6 per cent growth in taxes, with direct tax taking a slight knock, but indirect taxes expected to grow at a much higher pace --- from 9.9 per cent in FY18 to 19.2 per cent in FY19. This should more or less be achievable. On the non-tax and capital receipts front too, there doesn’t seem anything amiss. While receipts from dividends are kept flat, the disinvestment target has been kept reasonable. After achieving a whopping ₹1 lakh crore in FY18, it has set a lower ₹80,000 crore, which, given the Centre’s plan to list 14 CPSEs, including two insurance companies, seem achievable. The only weak link is the spectrum proceeds, which may not come in as there are likely to be few takers.

On the expenditure front, the Centre has again maintained a 10 per cent growth for FY19, positive for growth but weighing on fiscal deficit.

The Verdict

By factoring in a healthy expenditure target and a jump in indirect taxes, the Centre has kept little wiggle room for slippage in FY19. The joker in the pack still is underlying growth, which could upset the fiscal deficit target. The Centre has assumed a higher 10 per cent growth in nominal GDP for FY18 (up from 9.5 per cent as per CSO’s first advance estimates). It assumes a higher 11.5 per cent growth in FY19. While the higher government spending could drive growth, the targeted growth figure still looks ambitious.

Gross market borrowing stands at ₹5.99 lakh crore in FY18, up from ₹5.8 lakh crore budgeted earlier. For FY19, this figure goes up marginally by 1 per cent to about ₹6.05 lakh crore. The net borrowing at ₹4.6 lakh crore, however, is up 3 per cent.

All-in-all investors need to brace themselves for volatility in bond markets. Bond yields have already spiked by about 80 basis points in the past three months. With inflation inching up and fiscal slippages taking centre-stage, bond yields can remain within a narrow range with an upward bias.

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