The interim budget today took another big step forward in the remarkable journey of macro-economic stability that has been underway for some time now. We had dwelled on these in a recent communication (https://bandhanmutual.com/article/15865 ) including on the important implications that this may have for bond investors. While it was important to appreciate the context of the higher central government deficit of the past few years, it was nevertheless considered as probably the weakest aspect of India’s overall macro-economic story. With the 80 bps fiscal consolidation on budgeted fiscal deficit between FY 24 to FY 25, and the finance minister’s stated commitment to attain less than 4.5% deficit in FY 26 (implying at least another consolidation of 60 bps), India has now solidly ringfenced this aspect of our macro-economic story as well.
The table below presents key numbers from the budget.
Some takeaways as follows:
1. The budget aims to reduce the extent of dissaving of the public sector thereby allowing the private sector to step up more. However, the current account deficit at a country level of 1.5% of GDP or below fundamentally implies that aggregate dissaving has been well controlled and in fact has been coming off. Thus if for some reason the anticipated pick up in private sector investments gets delayed (owing to global uncertainties as an example), it will be perfectly logical for the government to dial back on the pace of fiscal consolidation. Conversely, if the government continues with its consolidation plan even in such a scenario then India’s current account deficit can easily fall to below 1% of GDP.
2. We had mentioned a ‘blue sky’ scenario in our previous note (link above): “the added attention to Indian bonds courtesy the index inclusion is happening at a time of adverse US fiscal dynamics and a possible long cycle top in the US dollar. On the other hand, India stands out as a growing economy with healthy macro-economic dynamics. This may eventually lead to larger bond allocations overtime than just the mathematical calculation related to index inclusion may suggest.” We are now more confident of this happening. More generally, we expect a continued diminishing of risk premia on India bonds in a global context. This may lead to a much more robust performance for bonds via compression in term premia than merely the scope for RBI rate cuts may suggest.
3. More immediately, the fiscal compression indicated will provide much comfort to RBI on attainment of its inflation target. Ideally the central bank should have little reason to delay relaxing its liquidity stance, especially as inflation has anyway been undershooting its latest forecast. At the same time it is hard to be completely deterministic about whether the shift happens now or in April. Irrespective, the extent of fiscal compression and its potential impact on managing aggregate demand has important implications for RBI contemplating net easing to its current monetary policy stance. The table below shows that total public sector deficit is poised to go towards FY 19 levels. Further, one should also note the extent of consolidation we have seen from the pandemic highs.
4. Going forward, and as seen in the table above, one will see both a compression in total public sector deficit as well as in center’s share in the same. Also most of the incremental demand on account of foreign flows will likely be in government bonds. Thus SDL and corporate bond spreads may henceforth be at more normal levels more consistent with the pre-pandemic averages than at the very compressed state that they have been till very recently. While for short / medium duration segments receiving these spreads may make sense, in our view long duration exposures should preferably be via government bonds. This point is also highlighted below where we have charted ratio of gross SDL to gross government bond borrowing.
We reiterate our earlier point that ‘muscle memory’ from the previous two years needs to now be modified to include quality bonds and duration addition to investor portfolios. Our actively managed bond and gilt funds have > 60% exposure in 30 year government bonds as on date. In short and medium duration funds we have used the recent widening of corporate bond spreads to add AAA bonds. As discussed above while these spreads are expected to remain wide, for such products carry considerations are somewhat more material than they are for longer / active duration products.
Source: Bandhan MF Research
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