Fiscal slippage is likely to lead to further spike in bond yields

In a surprise move, the RBI chose to retain the repo rate at 5.15 per cent. Ten-year government bond yields that had priced in a rate cut rose 13 bps to 6.59 per cent.

While the RBI has not ruled out further rate cuts, given that inflation will remain elevated in the near term, the central bank may extend the pause and look at further rate cuts only after the February policy announcement. Hence, the yield on 10-year G-Secs could remain elevated.

More importantly, it appears that fiscal deficit could move up significantly from the projected 3.3 per cent due to weak tax collections and sharp fall in nominal GDP growth. A substantial fiscal slippage, implying additional market borrowings, could lead to a further increase in bond yields.

Inflation worries

CPI inflation had moved past the RBI’s comfort level of 4 per cent to a 16-month high of 4.6 per cent in October, led by a spike in food prices. Food inflation, led by the spike in onion and tomato prices and a low base, is likely to remain elevated in the coming months. While the sharp moderation in core inflation (excluding food and fuel) has lent some comfort, high food inflation is likely to keep the overall CPI inflation figure elevated.

This could lead the RBI to take a pause in the February policy as well. Limited rate action could keep bond yields sticky.

GST collection

Based on the CGA provisional figures for FY19 (in which Income Tax grew by a modest 7 per cent), the estimated growth in Income Tax collections for FY20 works out to 23 per cent. For April to October 2019, CGA data suggest that the growth in net Income Tax has been just about 6 per cent. There is also a significant shortfall in GST collections.

While the surplus transfer by the RBI has offered some respite, it may not be enough to make good the shortfall in tax revenues. The corporate tax rate cut by the Centre will lead to significant revenue loss.

The weak underlying growth in the economy is a key dampener. While the real GDP growth has fallen from 8 per cent last year to 4.5 per cent this fiscal in the July to September quarter, the sharp fall in nominal GDP growth from 12.6 per cent to 6.1 per cent during this period is worrisome.

The Centre’s fiscal deficit target assumes an 11 per cent growth in nominal GDP growth for FY20 (from CSO’s FY19 estimates), which is a herculean task.

The Centre has pegged its gross market borrowings at ₹7.1-lakh crore in the current fiscal (from ₹5.71-lakh crore last year). For the April to September 2019 period, the issuance of government securities amounts to ₹4.42-lakh crore; the balance ₹2.68-lakh crore of gross borrowings, will be in the second half.

But if there is a significant slip in fiscal deficit, the supply of bonds could increase in the last quarter of the fiscal due to additional borrowings.

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