India’s government bond market may have missed a key element of the budget. Finance Minister Arun Jaitley struck a fine balance by cutting the fiscal deficit to 3.2% of GDP next fiscal year from 3.5% this year while allowing for a 25.4% increase in capital spending compared with last year’s budget estimate. He also sharply reduced the reliance on market borrowing to fund it. Despite that prudent stance, bond markets sold off.
Jaitley announced that net market borrowing will reduce next year to Rs3,480bn ($52bn) net of buybacks and redemptions. At first, the benchmark 10-year bond yield rallied to 6.38%, only to sell off shortly afterward. It’s always difficult to know exactly what information markets are trading on. In this case though, investors may have misunderstood the net and gross borrowing numbers. That confusion seems to have lingered with the 10-year bond yield closing the day at 6.43%, compared with 6.41% at the opening.
In absolute terms, the gross fiscal deficit is pegged at Rs5,465bn for fiscal 2018. Of this, just Rs3,482bn will be financed via market borrowing (net of buybacks and redemptions), which is Rs770bn lower than the Rs4,252bn budgeted for the current fiscal year. Properly understood, this reduction should help lower yields on government debt and leave more room for the private sector to tap the financial market.
In addition, gross market borrowing for fiscal 2017 also stands Rs595bn lower because of buybacks by the government as set out in budget documents. Adjusting for this buyback, government net and gross market borrowing for fiscal 2017 stands at Rs3,472bn and Rs5,225bn respectively.
This lower net borrowing is made possible by an increase in demand for securities issued against the government’s Small Savings programmes. With deposit rates at commercial banks falling sharply in the wake of demonetisation, people have been switching deposits to these programmes, which offer interest rates about 100-200 bps above those on commercial banks’ fixed deposits. Data in the budget shows that securities issued against small savings increased to Rs904bn in fiscal 2017 from a budgeted Rs221bn. This is budgeted at Rs1,002bn in fiscal 2018.
Jaitley: Striking a fine balance by cutting the fiscal deficit to 3.2% of GDP.
