The recent budget announcement has put forth clarity over the expectations into the coming financial year. The budget has remained consistent and continued the baton from the previous few years. There were neither great new announcements nor any negative surprises and it stuck to the theme of development at large while making investments to the future. The budgetary allocations have laid out the government’s borrowing plans while the outlay has been an aggressive capex oriented spend.
While one shouldn't make changes to their investment plans depending upon this annual ritual, this time though, one could make some adjustments especially in their debt portfolios. Though the rising inflation is not endemic to India, the extent of the impact is not yet in full glare like that of the west. The interventions by Indian government and the Reserve Bank of India (RBI) have been different from that of the west. While the western countries opted for higher fiscal spend combined with monetary easing, India wasn’t having a luxury to overspend and so the fiscal front was limited. The monetary stance however has been very accommodative to the emerging challenges.
This cautious approach has enabled the economy to wither the storm containing the stress in the economy even as the recovery has been endemic. The targeted govt’s spend had put the fiscal deficit under control and a slew of measures including Production Linked Incentives (PLI) has created momentum to growth. The surprise rebound in the tax revenues this financial year has helped the govt. manage the fiscal better than their own anticipation and budgeted levels.
The market (debt) participants expected the improved revenues to shrink the current year’s fiscal deficit to lower in the revised estimates. On the contrary the govt retained the deficit numbers unaltered leaving room for higher spend for the remaining period of this FY. That means, the govt must have a higher spending run rate than the last three quarters. This seemed a stretch considering the state govt’s inability to completely mobilize their spending due to the pandemic shocks, which could mean a better standing on the actuals once the period is over. That could retain an additional surplus into the coming fiscal.
The era of pliable monetary policy is over and the wish of inflation came back harsher than what the western economies are prepared for. The supply chain disruptions have turned relentless and the uneven infection waves are further adding woes to the turn to normalcy. The US Federal Reserve (Fed) in its recent policy review has clearly stated its intent to tighten not just the liquidity but also to hike the interest rates this calendar year. The expectations range from 3 rate hikes to up to 7 hikes which could change the years which will have repercussions across the globe and particularly on the emerging market economies.
The new budget estimates have projected conservative expectation upon revenues and on the expenditure too. May be the govt. was planning to retain some dry powder in case of any pandemic related health exigencies into the coming year. Though the current deficit has remained higher, the funding has been managed well as they borrowed lesser than what they’d initially budgeted. Interestingly, the Indian govt is pursuing a continuation of the deficit expansion and an increased borrowing regime into the next fiscal year. The concern among the market participants is due to the less docile monetary environment into the coming year. Also, from the domestic market capacity, the debt funding (borrowing) seems to have reached the brim of sustainability. The lack of announcement on the tax incentive for the foreign bondholders is thus a big dampener. Given that scenario, it would be fascinating to see how the govt would traverse. Of course, the possibility of inclusion into the global debt indices could give a fillip.
The conservative figures of the next fiscal are further compounded due to the lowered expectation of the nominal growth which is contrary to their very own economic survey report. The deficits have shot up across the nations due to the pandemic related spend and are expected to wind down this year. One thing is clear from the govt’s intent, growth has taken the driver’s seat than fiscal consolidation in the last couple of years. Though the capex is great motivator from the sentiment perspective, the borrowing stats are a concerning factor for bond markets.
So, debt investors are better off staying in the short end of the yield curve and floating interest rate funds could discount part of the rate hikes, if not completely. Conversely, higher money could be made when a sector or asset is under stress. A staggered investment over the next few quarters with a four-year horizon on the medium to higher end of the curve could prove profitable. Of course, the journey would be very volatile and so is the staggered strategy to counter it.
This article was originally published in The Hans India daily on 7th Feb '22.