Budget Eve : What to expect on 1st Feb – need to focus on Economics than Maths

This is the most widely watched macro-economic event in the calendar for India’s financial market participants and industry leaders – Union budget annoucements for next fiscal year.

Very simply put, Budget is interpreted by market participants in two parts – Mathematics (should have 5-10% weightage) and Economics (backbone of the fiscal plan - having 90-95% weightage). Mathematics is majorly concerning the Fiscal math (FD %age) and other assumptions on GDP growth percentage, revenue (direct & indirect tax, non-tax reciepts) and capital / operating expenditure.

Unfortunately, the Maths part attracts more attention by financial market, than does the underlying economics behind that. May be it’s natural, as markets are obsessed with numbers and optically the deficit percentage & resultant borrowing are most important variables. But only ‘optically’ it matters and then the underlying economics should take over.

How the deficit will be achievable and whether the revenue assumptions are credible – those are more paramount questions to answer. So, in almost all post-budget market movements, there is a knee-jerk rally or sell-off based on the maths part, as market takes time to analyse the economics behind the budget; and then market settles as per long term economic roadmap provided in the Finance bill.

Budget is essentially the annual fiscal plan, supported by a number of short term (1 year) and longer term (3-5 years) economic roadmaps. Now coming to FY24 budget estimates, ‘base case’ Fiscal deficit is priced in the market as 5.9% - 6% of GDP, with INR 16 – 16.5 trillion gross borrowing (nearly INR 12 trillion net borrowing). It could be tempting for Govt to show optically better FD %age in the 5.8 – 5.9% range, but the assumptions taken for that number should be credible. Broader fiscal roadmap till FY26 deficit target will be watched closely by global rating agencies and anything in the range of 4.5 - 4.8% FD target after 3 years should be achievable.

Further, market would look for growth cues in budget document, as the next full budget will be 17-18 months later and FY24 is expected to be year of slowing growth. A targeted growth oriented budget will be more prudent than a conservative or populist one. Some key initiatives and economic reforms could pave way for long term capital market performance –

1. Impetus on local manufacturing and targeted incentive on PLI
2. Combining ‘old’ and ‘new’ tax regime; or else making the New regime more attractive. Ever since launch of new tax regime 3 years back, there have been very few takers and in risk of getting termed as failure.
3. Rationalizing capital gains tax – uniformity across asset class
4. Quality of expenditure - higher percentage of capex, including investments on green energy & pivoting on 'Green Growth'
5. Specific incentive schemes for agriculature and MSME industries
6. Add or initiate tax on few focused segments – without impacting growth (example : UPI payments, tobacco products, crypto currency transactions)

Whatever range the Fiscal Deficit number is, the fixed income market will have to cope with historically high gross borrowing number. And thus, the means of financing – green bonds , any mention of off-shore route borrowing will be important to find some relief. Centre & state combined borrowing of INR 25 trillion will hit markets starting April ’23. So, regardless the immediate reactions on 1st Feb due to optical ‘Maths’, the bond market will experience ‘Economic’ reality in April 1st week onwards, as Gsec / SDL auctions will start. Demand – supply imbalance will be key driver for Gsec market in FY24 than any other factor. Rates market has already priced in RBI OMO purchase starting Sept '23 or even earlier; but not much balance sheet expansion can be justifiably done by RBI this year. Market will have to find buyer to this large supply and the usual major buyer banks will definitely not be the saviour this time. Banks will support credit growth & protect NIM by lending at 10-12% rate, or will buy SLR securities (Gsec & SGS) at 7.5 % ?

Answer is very obvious and such stage of credit cycle is not new to the fixed income market. We have seen how much steepening takes place for mid to high duration part of the curve in such multiple scenarios in the past. Analysis of fixed income demand for FY24 reveals that 'Excess SLR' part from scheduled commercial banks will contribute much lower Govt bonds demand than the same during FY23. So, this year fiscal expansion and higher borrowing could really become inflationary for India.

#indiabudget #fiscaldeficit #gsec #Indiarates #bondmarkets #fixedincomeinvestments #fundmanagement #debtmutualfunds #debtcapitalmarkets #IndiaGlobalRating

Disclaimer – above mentioned views are only based on personal research and has nothing to do with any house view of employer organisation, or any other institution.