Informist, Tuesday, Jul 23, 2024
By Aaryan Khanna
NEW DELHI – A minuscule cut in the government’s gross borrowing was not quite what bond traders had hoped for, and yet, they found enough comfort in the Union Budget for 2024-25 (Apr-Mar) to stay invested in the debt market.
The market swung between elation and despair when Finance Minister Nirmala Sitharaman set the current financial year's fiscal deficit aim at a lower-than-expected 4.9% of GDP, but cut gross issuance of dated securities by a token 120 bln rupees to 14.01 trln rupees. Of the total reduction in market borrowing, 60 bln rupees has already materialised as the government passed over the issuance of a green bond that was up for auction on May 31.
The government was widely expected to project a fiscal deficit of 5.0% of GDP, and a gross market borrowing of 13.81 trln rupees, according to Informist polls. Although the borrowing figure is perhaps the most important number in Budget documents as far as the bond market is concerned, there is a lot more to the Union Budget. Especially in the Budget presented today, there was a lot that was at risk of going wrong, but didn’t.
After the Bharatiya Janata Party failed to win a majority on its own in the recent Lok Sabha elections, there was the risk that the BJP-led National Democratic Alliance government could veer towards populist policies to regain public favour. The presence of the BJP’s new political allies in the government was also expected to make it difficult to stay the course on fiscal consolidation. Yet, Sitharaman stuck to the fiscally prudent script she has been following for three years now.
"While some near-term disappointment on the lack of dated borrowing cuts has weighed on bond market sentiments currently, we expect the bond markets to maintain their euphoria in the months ahead as demand-supply dynamics remain comfortable," Upasna Bhardwaj, chief economist at Kotak Mahindra Bank, said.
Despite the lack of a significant cut in borrowing, bond traders remained optimistic, convinced there is only one direction bond yields are going: down. The inflow of foreign portfolio investment due to India’s inclusion in global bond indices will ensure that net demand for government bonds exceeds supply this year. The prospect of interest rate cuts in the coming months also rules out a rise in yields. As a result, the choppiness during the day's trade was brief, and subsided by the end. The 10-year gilt yield was little changed at 6.97% today.
"Everything else is still a positive, so risk is high, but I'm comfortable keeping my portfolio like this if yields don't spike," the head of trading at a private bank said. "Even in the worst-case scenario, barring a black swan event, I know there's money to be made in six months' time between the carry and capital gains."
Traders may begin chasing short-term bonds after spending the better part of a year filling their portfolios with bonds maturing in more than 10 years.
SENSIBLE MATH
Every bit of bad news in recent times–such as a higher CPI inflation print for June–has been met by firm demand, with investors happy to stock up on the 10-year gilt as soon as its yield tops 7%. Sensible fiscal math in the Budget would likely keep this trend going, with estimates of tax collections and nominal GDP growth modest and likely to be met comfortably, dealers said.
With a fiscal deficit target of 4.9% for 2024-25, confidence in the government's medium-term aim of 4.5% of GDP by 2025-26 has risen, dealers said. In a note after the Budget, Fitch Ratings too said the government is likely to achieve its target of lowering the fiscal deficit below 4.5% of GDP by 2025-26.
None of the schemes outlined were seen as particularly inflationary, as some had feared after the electoral setback for the Narendra Modi-led NDA. Budget packages to states such as Andhra Pradesh and Bihar–in focus as strongholds of key coalition allies Telugu Desam Party and Janata Dal (United), respectively–were moderate.
Akhil Mittal, senior fund manager at Tata Mutual Fund, said the fiscal consolidation was "symbolic" even if the accompanying gross borrowing cut was marginal. Traders agreed that even if the numbers on dated market borrowing did not change, progress on fiscal consolidation would help bond prices in the medium term.
The government has also significantly cut its net short-term borrowing through the issuance of 91-day, 182-day, and 364-day T-bills, to (-)500 bln rupees from 500 bln rupees in the Interim Budget. This means the government will net redeem T-bills this year using its cash pile. Finance Secretary T.V. Somanathan, in a post-Budget press conference, said this was a conscious choice to reduce exposure to these instruments. Consequently, the cash drawdown to fund the fiscal deficit has increased to 1.40 trln rupees in 2024-25, down from the Interim Budget's tiny 35-bln-rupee allocation.
"The government has been wise to cut borrowing in the short term. One arrow has already been used this year for dated securities, by using the GST compensation cess," Shailendra Jhingan, managing director and chief executive officer, ICICI Securities Primary Dealership, said. "This allows the scope to broaden for a more enduring cut in borrowing over the next few years."
STEEPENING CURVE
The decision on cash drawdown and reduction in Treasury bill issuance will directly help with liquidity moving from the government's coffers into the banking system. This is likely to keep liquidity conditions easier in the remainder of the current fiscal year, a stark contrast to 2023-24, which was characterised by significant liquidity deficits, dealers said.
In such an environment where dated security borrowing remains high and there is a paucity of short-term securities, long-term bonds may have run out of steam. Real-money investors such as mutual funds are likely to shift additional inflows to buy short-term bonds, leading to the government bond yield curve steepening.
"The Budget makes a clear case for a steeper curve. Even if there's no sell-off, incremental allocation to duration will not increase," Mittal of Tata Mutual Fund said.
Bonds maturing between 30 and 50 years have been favourites of mutual funds in 2024 as they seek to capture capital gains when there is a secular fall in yields. To be sure, this is only a fiscal steepener and is reliant on easier monetary policy conditions. Treasury bill yields at auction are likely to fall in the coming weeks, though a reset may happen only when the quarterly borrowing calendars show the changes outlined in the Budget, dealers said.
"There is not much scope for short-term bond yields to fall on demand-supply alone, it will happen only when we get clarity on a rate cut," Jhingan said. "And I don't feel this Budget changes the monetary policy view at all." He said the spread of the 10-year benchmark gilt over the 2-year yield would not expand by more than 5-7 basis points after the Budget. Today, the spread between the two benchmark papers was 9 bps.
All in all, the Budget is one more risk event out of the way for bond traders. Even if there are no additional positives, the lack of negatives in the current market conditions is expected to keep bonds afloat-–unless there is a rude awakening. End
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