Bond market spooked, rupee rallies

Bond yields jumped following the tax rate cut on Friday, on concerns over the fiscal deficit missing out on the target of 3.3 per cent of gross domestic product (GDP), and amid fears that the government may borrow more in H2FY20.

The rupee, however, strengthened sharply following cues from the stock market. The yields on the 10-year bond closed at 6.790 per cent, from 6.638 per cent on Thursday.

The rupee rose to 70.945 a dollar from its previous close of 71.325. In intra-day trade, yields had risen to 6.866 per cent, while the rupee touched 70.85 a dollar.

The tax cuts will cost the government ~1.45 trillion. The government recently received ~1.76 trillion from the Reserve Bank of India (RBI) in dividend and surplus transfer. It had earlier declared a ~70,000 - crore infusion into banks.

“There will be fiscal slippage, given that tax cuts cannot be fully absorbed by spending cuts, but recall that the Budget had overestimated spending too. We estimate the fiscal deficit at 3.8-4.0 per cent, against 3.3 per cent announced in the Budget,” said A Prasanna, chief economist, ICICI Securities Primary Dealership.

On Thursday, RBI Governor Shaktikanta Das had said the central bank had room for more rate cuts. Prasanna expects a 25-basispoint rate cut in October and sees the repo rate bottoming out at 5 per cent.

“Further, the option of overseas borrowing could also be renewed. We expect the RBI to frontload its OMO (open market operations) purchases to contain yields,

Rupee/dollar spot

(Inverted scale) 7 1.33 Sep 19,’19 70.80 71.00 71.20

71.40 Sep 20,’19 with purchases starting as early as October,” Prasanna said.

The RBI had bought ~3 trillion worth of bonds from the secondary market under its OMO programme in the last fiscal year. This, along with a 110 -bp repo rate cut, brought bond yields down to about 6.50 per cent.

Even in March 2019, the 10-year bond yield was at 7.3 per cent, and as such, the

10-year G-sec yield

6.64 Sep 19,’19 (%) 6.90 6.80 6.70 6.60

6.50 Sep 20,’19 cost for the corporate sector will not rise materially because of t he spike i n yields, said Ashutosh Khajuria, CFO and executive director of Federal Bank.

“Yes, there will be extra borrowing, but what the finance minister has done today was overdue. The RBI had already done its part by the 110-bp rate cut; now the finance ministry had to play its part. Even if the fiscal deficit rises to 3.8-3.9 per cent and can be bridged through higher disinvestment, it won’t create a panic; rather, the market will like it,” Khajuria said.

Standard Chartered chief economist Anubhuti Sahay said larger tax cuts may scale back policy rate cut expectations. “While the market has drawn comfort from the RBI governor ’s comments on potential rate cuts, we expect concerns of fiscal slippage to dominate the price action,” Sahay said.

“The bond market did not take the fiscal announcement very well. The FM was unable to justify the fiscal concerns, thus the 10 -year yield surged nearly 25 bps, keeping rupee gains under check,” said Rahul Gupta, head (currency research), Emkay Global Financial Services.

The RBI had bought ~3 trn of bonds from the secondary market under its OMO programme in FY19