As Vijay Sharma, senior executive vice-president at PNB Gilts, pointed out, the bond market was lulled into believing that whatever measures that the government will take to revive the economy will be done in a manner that will not have too much of fiscal implications.
Bonds sold-off on Friday with the 10-year benchmark yield rising by 24 basis points to hit 6.877% during the day after the government announced measures to boost the economy, including a cut in corporate tax rate, which the market believed may push the fiscal deficit higher and limit the space for further monetary action by the central bank.
The benchmark yield closed Friday’s trading session up 15 bps, at 6.789%. As Vijay Sharma, senior executive vice-president at PNB Gilts, pointed out, the bond market was lulled into believing that whatever measures that the government will take to revive the economy will be done in a manner that will not have too much of fiscal implications.
“What happened on Friday is exactly opposite to what the government has been claiming. That is the reason for the exaggerated sell-off in the bond market. Though the steps announced are good for the economy; from the perspective of revenue implications and fiscal deficit, it was negative and the bond market had good reasons to be spooked. The market still believes that the RBI may deliver a cut in the repo rate in the upcoming monetary policy,” he said.
The Reserve Bank of India (RBI) has cut the repo rate by 110 basis points so far this year. A noteworthy thing is that despite a 35 bps reduction in the repo rate in the August monetary policy, the benchmark yield has pared all the gains made during that period and is currently trading at its highest level since the first week of July.
RBI governor Shaktikanta Das had stated in his speech on Thursday that with inflation likely to remain low over the next one year, there is room for interest rate cuts. However, with such strong fiscal measures being announced, experts believe the rate cut in the October monetary policy may not be to the same tune as was expected earlier.
Corporate tax rate cut decoded! Why FM Sitharaman’s announcement is a Diwali bonanza for economy
Suyash Choudhary, head-fixed income at IDFC Mutual Fund, said the market wasn’t expecting an incremental fiscal stimulus. “The assumption of the bond market was that although there are some fiscal risks, they will not manifest for more than 10-20 bps of the GDP. The implications are that the bond supply may go higher and the quantum of interest rate cuts may go down. I believe repo rate will bottom out at the 5-5.25% levels,” he said.
Ananth Narayan, professor-finance, SPJIMR, also agrees that worries on the fiscal side is impacting the bond market. “So far, we have been seeing monetary stimulus in the form of rate cuts, liquidity, open market operations (OMOs) etc. Now the government is clearly pushing the fiscal lever as well. The fiscal situation is already stretched even as GST collections are not up to the mark. On top of that, a Rs 1.4-lakh-crore tax cuts clearly is going to intensify the concerns. What we are seeing in the bond market is a reflection of worries over a potential increased government borrowing in the wake of fiscal deficit, a likelihood in increase in inflation, and the possibility of a limited monetary space going forward,” he said.