November 07, 2019
Quantum Fixed Income Team
Indian bonds did well in the last month on aggregate basis though there was huge divergence between the performances of various maturity segments. The shorter maturity bonds outperformed the longer segment.
The bond yield curve steepened further as the front end bond yields (upto 5 year maturity bonds) eased by 10-20 basis points while the longer maturity bond yields remained somewhat stable. The rally in short maturity bonds was due to easy liquidity conditions and a 25bps rate cut by the RBI. Though on the other hand mounting pressure on the government’s fiscal position kept the longer segment of the bond curve under pressure.
Government’s tax revenues grew by mere 4.2% yoy in the first 6 months of the fiscal year 2019-20. This was much lower than the budget estimate of over 25% growth for the full year. Moreover, reduction in the corporate tax rates were announced on 20th Sep thus this data does not reflect the impact of reduced tax rate which would further hurt the government’s revenue in the second half.
Despite the sluggish tax collections, Revenue receipts were up 18% yoy due to large Dividend paid by the RBI which also includes one-time transfer of Rs. 520 billion on account of excess capital reserves.
On the expenditure front, both the Revenue Expenditure and Capital expenditure have seen a marked improvement in the July to September quarter pulling up the yoy expenditure growth for the H1FY20 to over 14%.
We estimate the gross tax revenues to fall short of the budget target by around Rs. 2.8 trillion (1.3% of GDP) in FY20. Adjusting it for lower assignment to states and the one-time windfall from the RBI, the net shortfall in total receipts could be ~ Rs. 1.38 trillion (0.7% of GDP). That would mean significant expenditure cuts if the government intends to meet the fiscal deficit target of 3.3% of GDP.
The government has budgeted for over 20% increases in its revenue expenditure in FY20 thus have some headroom to cut spending. We estimate the fiscal deficit to widen by ~Rs. 600 billion (0.3% of GDP).
The bond market will continue to take cues from the developments on the fiscal front. Any fiscal stimulus from hereon could be negative for the bond markets while progress on the privatization/disinvestment of central PSUs will be supportive.
At the current level of term premium with the 10 year government bond trading 130 basis points over Repo rate, much of the fiscal risk is already priced in the market. On the positive potential rate cuts and easy liquidity conditions will continue to support the bond market.
In our opinion, when fiscal uncertainty goes away, bond yields will likely fall from the current levels. Though we do not see a structural bull run and any positioning would be a tactical call only.
We believe the best of the bond market rally is behind us now and Investors in bond funds should keep the market risks in mind while trying to benefit from any further fall bond yields.
Investors with low risk appetite should stick to short maturity funds or Liquid Funds to avoid any sharp volatility in their portfolio value. However, while choosing such funds one should be aware of the credit risk and prefer funds which take low credit and liquidity risks.
Investors should also note that the credit crisis which began in the bond markets post IL&FS default is not over yet and investors should remain cautious and should always choose debt and liquid funds which priorities safety and liquidity over returns in the current times.
Data Source: Bloomberg, RBI
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