From the bond market’s prospective the budget had more negatives than positives. Increase in fiscal deficit in the current fiscal year to 9.5% of GDP and target of 6.8% for FY22 was a surprise. This, along with the extended fiscal consolidation roadmap indicate that the bond market will face heavy supply pressure not just in this year but over many years. State governments may also pursue similar expansionary fiscal policy.
RBI’s role in facilitating this kind of market borrowing would be critical to determine its impact on the bond markets. Nevertheless it seems that the bond yields have already seen the bottom and reversal is coming sooner than anticipated.
Increased government spending for extended period will create inflationary impulse over medium term. Government’s tax proposals particularly related to introduction of new cess and import duties on various products could also cause inflation to rise. The RBI may find it difficult to support the government’s borrowing program if inflation comes back.
Proposal to create a permanent institutional framework to provide liquidity in the corporate bond market is a positive development. In recent past many debt funds faced this problem of liquidity crunch and system level liquidity infusion by the RBI was not trickling down to the needy borrowers. This move will go a long way in the development of the corporate bond market. This will also bring down the liquidity and credit premiums and thus cost of capital for borrowers.
Investors should lower their returns expectations from fixed income funds and should follow a conservative approach while choosing fixed income products. Interest rate are likely to move higher in coming years. Long duration funds may face high volatility in coming months.
Suman Chowdhury, Chief, Analytical Officer, Acuité Ratings & Research on Bond Market
“The government has announced that a permanent institutional framework will be set up which will facilitate the purchase of investment grade bonds from the market. While further details on the modus operandi for such a framework is awaited, it will clearly help to deepen the corporate bond market which continues to face liquidity challenges. In our opinion, this will be fairly positive for debt mutual funds particularly credit funds which had witnessed significant outflows last year due to poor liquidity in certain corporate papers. This will also help to reduce the volatility in secondary market yields of relatively lower rated bonds in the AA and A category. The budget has also proposed the formulation of a single Securities Market Code by consolidating the provisions of Securities Contract Act, SEBI Act and other applicable laws for the bond markets. Further, an investor charter will be codified which will incorporate the rights of all financial investors across all financial products, thereby ensuring the protection of the latter’s interests.”
Mr. Avnish Jain, fixed-income head, Canara Robeco Mutual Fund
The Union Budget 2021-22 threw a huge negative surprise for debt markets, as fiscal deficit continues to remain high with glide path being moderated. Further gross borrowings numbers increased for current fiscal by Rs.80000cr, pushing the already stretched gross borrowings to Rs.14 trillion. For FY2022 there is only marginal drop in gross borrowings @ Rs.12.06 trillion (net borrowing of Rs9.75 trillion). This is sharp jump from gross borrowings in pre-pandemic era of around Rs.7.2 trillion (FY2020). While it was expected that gross borrowing numbers are likely to remain high, only marginal downward change in borrowing, from FY2021, surprised markets. Fiscal deficit is now pegged at 9.5% for FY2021 and then coming down to 6.8% in FY2022. The government is planning to introduce a new glide path in FRBM, so as to take fiscal deficit to 4.5% in FY2025. This is much higher than earlier envisaged FRBM target of 3% in medium term. This may be viewed as a negative by international bond investors.
Markets have already reacted sharply to the Budget with across the board selloff. 10Y yield climbed by about 16bps at close. Similar sell off was also seen in corporate bonds. With higher borrowings, greater RBI support may be required for smooth passage of borrowings. FII flows in debt have also been marginal in FY2021 and with higher projected fiscal numbers, foreign investors may choose to stay away further impacting the demand side. With the Monetary policy scheduled by end of the week, market participants will keenly watch views from MPC members on the enhanced fiscal stimulus as well change in fiscal glide path, as well as likely impact of large fiscal on inflation. The change in fiscal glide path may also be negative from the country rating perspective and any adverse comments from international rating agencies may be bond negative. In the short term markets are likely to remain negative awaiting further clarity from government / RBI on steps taken to ensure smooth passage of large borrowing programme. 10Y may remain within 6%-6.25% range in the short term.
Arvind Chari, CIO , Quantum Advisors
It is good to see the government focus on reviving growth. The reaction in the equity markets is a testament to that. It’s by far the best budget for equity markets. Lots of positive surprises and no major negatives.
The bond markets haven’t liked the budget at all. It’s a shock. No one expected that PM Modi will agree to shed his fiscal conservatism to such an extent. Long term Bond yields have already headed higher. We would expect the RBI to also begin normalization and interest rates hikes in the coming months. Bond yields have bottomed and the best of the returns from long bond funds are behind us.
The key of course is the long-term outlook. This increase in spending over the next 4 years needs to revive growth back to at least the 7% level. If that happens, then the higher deficit will be forgiven. If not, high inflation and high deficits can cause macro instability in the years ahead.
Mr. Chirag Mehta, Sr. Fund Manager-Alternative Investments, Quantum Mutual Fund
Nirmala Sitharaman pleasantly surprised gold markets by announcing the reduction of custom duty on gold from 12.5% to 7.5%. With reduction on one hand, they increased the duty on the other by including a freshly introduced levy called the Agriculture Infrastructure and Development cess of 2.5%. The net effect will be lesser than the 5% reduction that the headline number suggests. The immediate effect of this move will be that gold prices will decline to the extent of reduction of levies. All those holding gold will see the value erode to that extent whereas all those who want to buy more will get it relatively cheaper to that extent.
Still, this is a welcome move and will be appreciated by the industry as it will reduce price distortions, bringing domestic gold prices closer to International prices to the extent of reduction in levy. This will enable more efficient functioning of the gold markets in India and discourage illicit gold imports of the precious metal.
Higher intervention through higher customs duty has all this while ensured that India could never be at the center of the global gold markets despite being the largest consumer and thus remain a price taker. Price distortions make it difficult to channelize the hoard of India’s gold savings into circulation and thereby integrate the gold market with other financial markets.
The finance minister termed this reduction as “rationalizing the gold duty” given prices have risen since the last increase. This rationalization has been long due given duties were as low as Rs. 100 per 10 grams during the previous BJP regime of 2001-04 when then Finance ministers Yashwant Sinha and Jaswant Singh had taken positive steps of duty reduction amidst an optimistic view of the development of the Gold sector. We hope this duty reduction is aimed further at removing these price distortions in form of levies and truly think about developing the gold sector and bring India at the center of International gold markets.
The Finance minister also set the ball rolling for the creation of the proposed spot gold exchange by announcing that the ministry will be notifying the Securities and Exchange Board of India (Sebi) as regulator for gold exchanges. A gold exchange is the need of the hour as many of the key market players are currently under served by the current market structure and thereby stand at a disadvantage. Many of the important gold players demand a market infrastructure that helps bring transparency and standardization that a spot exchange could offer. Today’s announcement brings us closer to realizing this objective as the appointment of a regulator will now move things forward on this front.
The creation of a spot gold exchange will bring twin benefits for Gold ETFs by adding to the liquidity pool as well as leading to more efficient price discovery.