#39;RBI will have to support bond market as govt doles out populist measures#39;
The Interim Budget was mostly along expected lines. It was expected to be a ‘make all happy’ kind of a budget with special focus on the farm sector, SME sector and the middle-income class. There was something in it for everyone but the assumptions underlying the budget seem to be on shaky ground and that is what spooked bond vigilantes.
The yield on the old 10-year benchmark bond ended the session at 7.61 percent after touching an intraday low of 7.42 percent as the markets turned the focus from the FM’s speech embellished with rhetoric and parsed the fine print of the budget document.
Though the January GST collections crossed the Rs 1 lakh crore mark, the centre’s estimate of Rs 7.6 lakh crore (i.e. centre’s share of GST collections) in GST collections in FY20 seems a little ambitious. The disinvestment target of Rs 90,000 crore too seems a tall order unless divestment of Air India goes through.
The budget deviates from the FRBM target of fiscal deficit of 3.1 percent of GDP for FY20 by 0.3 percent mainly on account of the Rs 70,000 crore package announced for the farm sector.
The budget saw the announcement of first of its kind income transfer scheme at the central government level, sought to replicate the success of Rythu Bandhu in Telangana and KALIA in Odisha, granting Rs 6,000 per year to farmers with less than two hectares of cultivable land. The scheme is likely to benefit 12 crore farmers.
The gross borrowing for FY20 is pegged at Rs 7.04 lakh crore and net borrowing at Rs 4.73 lakh crore. Excluding a buyback of Rs 50,000 crore, the markets will have to absorb Rs 4.24 lakh crore of central government securities, which is quite an ask given the lack of FPI interest in buying Indian assets ahead of the general elections.
Domestic institutions also do not seem to be too keen on buying duration, as there is uncertainty about the overall direction of interest rates. The RBI would have to continue to fill the void and support the bond markets just like it did this year by buying around 80 percent of net issuance of central government securities.
While crude prices do not seem a threat to the economy at current levels, they have shown a propensity of inching higher over the last few sessions. Saudi Arabia is committed to cutting production and fresh US sanctions on Venezuela could further constrict supply. Waivers from US’ sanctions on Iran granted to a few countries are set to expire from May 2019 onwards and this could put further upward pressure on crude prices.
Domestic stocks and bonds have underperformed in an otherwise supportive global risk environment. The US Federal Reserve looking to level out its balance sheet (i.e. ending balance sheet reduction) is positive news for EM assets as it would address the concerns of receding global liquidity. The Federal Reserve is now expected to stay on hold through the year as opposed to expectations of two hikes a couple of months back.
The US economy, on the whole, seems to be doing quite well (despite the US-China trade tensions and the longest partial government shutdown in history) as indicated by the latest Manufacturing PMI and January employment data. However, the rupee has been the worst performing EM currency YTD. FPIs sold $ 600 million in equities and $ 200 million in debt in January. FPI flows are likely to elude the domestic markets until election uncertainty is out of the way.
In the absence of any meaningful inflows, USD/INR could continue to drift higher gradually. 70.80-71.80 has proven difficult to break for the pair. Break on either side could initiate a new medium-term trend. The correlation of USD/INR with the broader US dollar could remain weak.
Corporate bankruptcies and allegations of diversion of funds could further dampen sentiment onshore. Spreads of NBFCs over other companies of similar ratings need to be monitored for any re-escalation of NBFC crisis.
The author is CEO at IFA Global.
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