FROM THE RESEARCH BUREAU. It’s a good bond

Bond markets can heave a sigh of relief now that the Finance Minister has rolled up his sleeves and is ready to stick to the daunting fiscal deficit target of 4.1 per cent set by his predecessor.

The new Government continuing with fiscal consolidation is a huge positive, as this could ease inflationary pressures and give the RBI much needed headroom to ease monetary policy. A conducive fiscal deficit would mean lower threat of a downgrade by international credit rating agencies. All this should help companies borrow at reasonable rates without jostling with the Centre for money.

While all these are positives, there remain niggling doubts about the Government’s ability to stick to its fiscal targets. While the Government seems realistic on its inflation expectations, the GDP growth projection of 5.4 per cent assumes a significant economic recovery in 2014-15.

Also the Budget assumes an improvement in the tax-to-GDP ratio from 10 per cent to 10.6 per cent in 2014-15. The Centre’s fiscal deficit for the first two months of this financial year has already touched about half the amount estimated for all of 2014-15 in the Interim Budget.

There could also be doubts over the disinvestment target for 2014-15 set at ₹43,425 crore, more than twice the amount of ₹16,000 crore raised in 2013-14. Bottom line: the fiscal deficit target will not be very easy for the new Government to achieve.

But even if we assume that the Government will manage to keep fiscal deficit under control, what does this mean for bond markets? A fiscal deficit of 4.1 per cent means that gross market borrowing stands at ₹6 lakh crore, very much at the same level as in the Interim Budget. This is six per cent higher than borrowings in 2013-14. However, the net borrowing at ₹4.6 lakh crore is marginally lower than the 2013-14 figure, which is a good signal for bond markets as it indicates that the Centre will not further crowd out private debt.

Given that the Budget has not sprung any surprises on the borrowings front, the yield on the 10-year G-Sec may not budge much from here. The yields have been in the 8.6-8.8 per cent range for a while now and may continue to remain within these limits. However, the RBI’s decision to reduce its open market operations (OMOs) to buy up G-Secs will impact demand. In 2012-13, the RBI conducted OMOs to the tune of ₹1,50,000 crore, 33 per cent of the Government’s net borrowings that year. However in 2013-14, this number was down to almost 10 per cent. With the RBI reducing bond buybacks through OMOs, the yields are unlikely to come down. Rate cuts by the RBI may materialise only when CPI inflation comes down to seven-per cent levels by March 2015.

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