Modi Budget Seen Slipping With India Bonds Turning Asia's Worst

  • Investors have lost money on rupee sovereign debt in 2016
  • Gross government borrowing to be 6.8 trillion rupees: survey

Indian sovereign bonds have turned into Asia’s worst performers in 2016, from the best in the previous two years, amid concern Prime Minister Narendra Modi’s budget will show fiscal discipline is slipping away.

The government may seek to borrow an unprecedented 6.8 trillion rupees ($99 billion) in the financial year starting April 1, according to the median estimate in a Bloomberg survey of 10 fixed-income strategists and economists before the fiscal plan is announced Monday. That’s 13 percent higher than this year’s 6 trillion rupees estimate. The deficit target may be raised to 3.7 percent from 3.5 percent.

HSBC Holdings Plc and Barclays Plc last week reduced their outlook on Indian sovereign bonds saying more supply will put upward pressure on yields. Modi looks set to loosen budget goals for a second consecutive year amid a higher civil-servant wage bill and increased spending to support growth in Asia’s third-largest economy during global market turmoil.

“A larger deficit will definitely increase the government’s reliance on borrowings from the market,” said Himanshu Malik, a strategist at HSBC in Hong Kong. “If that happens, the government will definitely lose credibility, foreign investors will be disappointed and the central bank won’t have much scope to cut rates further. That will be quite negative for bonds.”

Rupee-denominated sovereign debt returned 8.1 percent last year and 16.5 percent in 2014, Bloomberg indexes tracking major Asian markets show. Investors have lost 0.03 percent on the bonds so far this year, compared with returns of 4.6 percent from Indonesian notes, 3.7 percent from securities in Thailand and 1 percent on Chinese debt.

Foreign holdings of Indian corporate and government bonds dropped 27.5 billion rupees in the last three days, the most since Dec. 29, data from National Securities and Depository Ltd. show.

QuickTake India's Aspirations

While the budget always garners market attention, this year it is also key to the path of monetary policy. Sovereign debt could lose favor among investors if the fiscal-deficit targets are missed, Reserve Bank of India Governor Raghuram Rajan warned last month. He kept interest rates unchanged on Feb. 2, signaling he’d watch the budget before adding to the biggest interest-rate cuts in six years in 2015.

Even though steps to boost revenue through taxes may help the government meet its deficit target of 3.9 percent of gross domestic product in the 12 months ending this March, the goal for the period through March 2017 is seen pressured by a proposed increase in salaries for millions of civil servants and higher pensions for military personnel.

Some fiscal progress was made this year. The government’s gross borrowing is seen at 5.85 trillion rupees, less than the 6 trillion rupee projection, while net borrowing is at 4.4 trillion rupees, compared with 4.56 trillion rupees, according to central bank data.

Yield Jump

The yield on sovereign notes maturing in January 2026 has jumped 25 basis points since the new 10-year benchmark was issued early last month to 7.83 percent in Mumbai on Wednesday. One-year interest-rate swaps have climbed to an almost seven-week high of 7.03 percent, suggesting traders are paring bets for more rate cuts.

The rupee has weakened 3.5 percent in 2016 in Asia’s worst performance after the South Korean won. Barclays last week said it prefers shorter-maturity Indian bonds as it trimmed duration on rupee debt to neutral from overweight. HSBC reduced the allocation of 10-year notes in its model portfolio to “mildly bullish” from “bullish.”

‘Be Credible’

“In the past two months, uncertainty around fiscal consolidation and concerns about slippage have risen, with the government looking at proposals to raise its budget deficit targets in order to steer more spending into infrastructure,” Rohit Arora, an interest-rate strategist at Barclays in Singapore, wrote in a Feb. 18 report. The “long end” of the bond-yield curve “will be rangebound to weaker amid sustained higher supply.”

While gross market borrowing is estimated at 6.8 trillion rupees, the net issuance, excluding redemption payments for existing securities, is seen rising 5.3 percent from this year’s target to 4.8 trillion rupees, the median estimate in the Bloomberg survey showed. Besides debt sales, the government is expected to raise 500 billion rupees selling treasury bills and state governments are seen raising another 2.2 trillion rupees, according to forecasts by Australia & New Zealand Banking Group Ltd.

“The budget needs to be credible, or else it’s a risk that may put further pressure on the bond market,” said Vivek Rajpal, an interest-rate strategist at Nomura Holdings Inc. in Singapore. “If the deficit target turns out to be higher, say at 3.7 percent, markets will not take it kindly.”

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