Modi Budget Resolve Tested as Bonds Have Worst Start Since 2011

  • Rupee, bonds and stocks all posted declines in January
  • Budget critical from a markets point of view: Deutsche Asset

Investor confidence in Prime Minister Narendra Modi’s ability to meet his budget targets seems to be dwindling.

The annual budget, which garners significant market attention each year, assumes greater importance this time as markets test Modi’s commitment to fiscal consolidation that is also key to determining the path of India’s monetary policy after the biggest interest-rate cuts in six years in 2015.

The rupee, sovereign bonds and stocks posted their steepest January losses since 2011 as concern mounts that a higher wage bill and increased public spending to spur economic growth will derail the government’s plan to narrow the budget deficit. A China-led turmoil in emerging markets and the prospect of more increases in U.S. borrowing costs gave investors more reasons to dump Indian stocks, resulting in the biggest outflows since August and making the rupee Asia’s worst-performing currency last month.

“There has been some concern emerging about the fiscal consolidation roadmap,” said Kumaresh Ramakrishnan, Mumbai-based head of fixed income at Deutsche Asset Management India Pvt., which manages 247.9 billion rupees ($3.7 billion). “The budget is critical from a markets point of view as it would provide further guidance and direction.”

While steps to boost revenue through taxes may help the government reach the deficit target of 3.9 percent of gross domestic product in the 12 months ending March 31, the 3.5 percent goal for the period through March 2017 is seen pressured by a proposed increase in pay for millions of civil servants, coupled with higher pensions for military personnel.

The government may have to reassess its fiscal projections for the year starting April 1, the Finance Ministry said in a mid-year review published Dec. 18. That could see the administration borrowing more to bridge the shortfall and also threatens to fuel inflation, limiting the Reserve Bank of India’s room to ease monetary policy.

‘Controlling Spending’

Benchmark 10-year bond yields rose two basis points in their first January increase in five years and have climbed another four basis points this month to 7.82 percent as the RBI refrained from lowering borrowing costs for a second straight meeting.

“Structural reforms” in the Feb. 29 budget “that boost growth while controlling spending will create more space for monetary policy to support growth, while also ensuring that inflation” stays on course to hit the target of 5 percent in March 2017, the RBI said in its post-policy statement on Tuesday.

‘Rupee Penalized’

While rupee sovereign debt handed investors a return of 0.7 percent last month, it was the smallest for any January period since 2011, according to indexes compiled by Bloomberg. Returns were 8.1 percent last year and 16.5 percent in 2014, the best among major Asian markets for both the periods. Local-currency debt has returned 4.8 percent in Indonesia, 2 percent in Thailand and 1.5 percent in Malaysia so far this year.

India’s bond underperformance is “coming off the back of a substantial outperformance,” said Caroline Gorman, a London-based investment manager at GAM International Management Ltd., whose team manages about $4 billion in emerging-market debt. “It may be that the rupee has been penalized this year to the extent it is viewed as an equity-sensitive currency, and in light of the poor performance of global equities so far this year.”

The benchmark S&P BSE Sensex index of shares has plunged 5.9 percent in 2016, including January’s 4.8 percent slump, as a China-led equity rout saw global funds pull out a net $1.7 billion from Indian stocks. The rupee weakened 2.2 percent this year through Friday. The currency extended losses on Monday, falling 0.3 percent to 67.8350 a dollar in Mumbai.

Sovereign debt could lose favor among investors if the fiscal-deficit targets are missed, RBI Governor Raghuram Rajan warned last month. “We should be very careful about jeopardizing our single most important strength during this period of global turmoil: macroeconomic stability,” he said.

“China growth concerns, falling oil prices and uncertainty around U.S. rates remain the dominant drivers of risk,” said Anders Faergemann, senior sovereign portfolio manager for emerging-markets fixed income in London at PineBridge Investments, which oversees more than $84 billion globally. “Although India remains more isolated from these themes than most emerging-market countries, Indian assets have not gone unscathed from the general risk aversion.”

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