February 5, 2019
With the national elections a few months away, the 2019 Union Budget in India was largely centered around populism. One aspect of the budget that has taken the hot seat of discussion is the fiscal deficit number. The fiscal deficit is projected by the government at 3.3% of GDP (a slip from the earlier projected 3.1% of GDP). This, however, has confused and raised questions over the authenticity of the fiscal math. What has complicated the math is that months of revenue slippages, coupled with rising expenditures due to populist spending owing to an election year, should damage the fiscal deficit more than the projected 3.3%.
We believe that the fiscal deficit target for 2020 is aggressive and takes into account some optimistic revenue expectations; expectations from personal taxes, GST collections, and corporate taxes to fund measures like reduction in tax burden of middle-income households and direct cash transfer to farmers.
The market’s reaction
|Mr. Arindam Sengupta, Deputy CIO, US Freedom Capital|
A fiscal deficit target of 3.4% for FY-19 was seen as encouraging by market participants even as the actual deficit number for April-Dec’18 came at 7.01 lakh crore. This was roughly 113% of entire budgeted estimate for FY’19 (6.24 lakh crore).
The government’s fiscal deficit roadmap for FY-20 (3.4% against a market expectation of 3.1% to stick to the FRBM Act) was perceived as a negative surprise for bond markets. Both the old 10-year benchmark (7.17% GS 2028) and new 10-year benchmark (7.26% GS 2029) ended 18 bps and 12 bps higher than previous days close (as on 4th Feb’19).
In our view, the market seems to be jittery and fearful of an upward revision in fiscal deficit targets. Anticipation of the budget being announced after the new government is formed, post the general elections, has heighted this fear, with some expectations of the deficit target could reach 3.6% of GDP.
The Indian rupee echoed similar sentiments and trended lower by roughly 70 paise to 1 US$ between end of day pre-budget until February 4th.
With Indian fixed income being slightly weak, and RBI expectations to persist with a relative hawkish tone, we can expect fixed income investments, especially medium to long term papers, to continue being under pressure. This is also due to the fact that the government has done their bit towards public spending coupled with RBI’s necessity to balance their tone to adhere to the inflation glideslope. This presents a perfect opportunity to diversify into a stable asset class such as USD denominated fixed income investments, which benefit from high real yields and continuous appreciation of the dollar against the rupee.
To put this into perspective, the USDINR when the previous union budget was released (February 1st, 2019) opened at 63.72. It closed at 63.98. Currently, it is trading at 71.76 (a depreciation of 12%) while Nifty is at 10912, down from 1st Feb 2018 which saw closing levels of 11,016 (down 1%).