By Lakshmi Iyer
The B-day arrived in style as always. For Bond street, this is more celebrated than Valentines day – though both are in the same month.
The economic survey did attempt a realistic stock taking of the economy, however, Budget math is something which is most watched factor for bond market participants. So how did the math look like?
For starters, capital expenditure was increased from Rs 5.54trn BE (INR 6.3trn RE) in FY22 to Rs7.5trn in FY23 (+35% YoY) or 2.9% of GDP. Whoa that’s a big jump indeed. Fiscal deficit in FY22 was higher than expected at 6.9% (vs. budget of 6.8%) and in FY23 6.4% of GDP (vs market consensus of ~6%). This could also mean additional borrowing for the current FY, though the government cash balances could be dipped into as well. For FY 2023, the gross borrowing has been pegged at INR 14.32 tn (after adjusting for the conversion of shorted dated maturities for long dated bonds). This, to our mind, does not bode well for bond yields. The markets are already reeling under weekly government bond supply with no commensurate demand to match. Auction devolvements are on the rise, indicating tepid response. Add to that, markets were hopeful of some roadmap towards India bond inclusion into global bond indices and also some clarity on taxation status for Foreign Portfolio Investors (FPIs). On both these counts, the budget did a Mr India act, further disappointing the markets. FPI bond buying could have been a potential strong demand lever, which may not be immediately available. On the positive side, the revenue estimates have been quite modest leaving some room for upside there reducing the extent of deficit – this is a more likely back ended in nature. The centre assistance to states to the tune of INR 1 tn for specific capital investments is positive for the states.
Way forward
For bond street, the messaging is clear – carry trade is the order for the day. The current bond yields are pricing in very aggressive rate hikes (80-100bps) by the RBI over the next 12 months. This seems a tad far-fetched at the current juncture as RBI seems more in favour of gradual adjustment in rates than abrupt changes. Hence fixed income investors could remain invested in short/mid duration funds and try match their investment tenure to the portfolio durations to the extent possible. Floating rate bonds (FRBs) come to rescue in such an interest rate scenario as incremental rate resets on such instruments tend to be on the higher side. State development loans (SDLs) also look good form a carry perspective. Finally, the RBI MPC would lead the way forward in terms of rate expectations and policy stance. We assign a high chance of reverse repo rate hike in the upcoming RBI MPC meet. In conclusion, we see no reason to panic – as carry advantage in fixed income is huge given the massive steepness in the yield curve.
(Lakshmi Iyer is Chief Investment Officer of Debt & Head of Products at Kotak Mahindra Asset Management Company. The views expressed are author’s own.)
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