By Pankaj Pathak
From the bond market’s prospective the budget had more negatives than positives. Increase in fiscal deficit in the current fiscal year to 9.5% of GDP and target of 6.8% for FY22 was a surprise. This, along with the extended fiscal consolidation roadmap indicate that the bond market will face heavy supply pressure not just in this year but over many years. State governments may also pursue similar expansionary fiscal policy.
RBI’s role in facilitating this kind of market borrowing would be critical to determine its impact on the bond markets. Nevertheless it seems that the bond yields have already seen the bottom and reversal is coming sooner than anticipated.
Increased government spending for extended period will create inflationary impulse over medium term. Government’s tax proposals particularly related to introduction of new cess and import duties on various products could also cause inflation to rise. The RBI may find it difficult to support the government’s borrowing program if inflation comes back.
Proposal to create a permanent institutional framework to provide liquidity in the corporate bond market is a positive development. In recent past many debt funds faced this problem of liquidity crunch and system level liquidity infusion by the RBI was not trickling down to the needy borrowers. This move will go a long way in the development of the corporate bond market. This will also bring down the liquidity and credit premiums and thus cost of capital for borrowers.
Investors should lower their returns expectations from fixed income funds and should follow a conservative approach while choosing fixed income products. Interest rate are likely to move higher in coming years. Long duration funds may face high volatility in coming months.
(The author is the Fund Manager – Fixed Income, Quantum Mutual Fund. Views expressed are his own.)