What are the bond markets telling us?
It is likely that the market is anxious about a widening fiscal gap adding to extant inflation pressures bred by both domestic and global factors
December and tightening of global liquidity in the year to come. Also, there are mounting fiscal deficit worries on the domestic front. The government’s PSU re-capitalisation scheme and the likely shortfall in GST collection are among the key factors that pushed bond investors to consider the risk of a fiscal slippage.The government’s fiscal deficit incidentally touched 96 per cent of the full-year estimate at the end of October.
Thus, if we look at the picture the bond market is painting, it isn’t quite pretty at first glance. The markets clearly don’t like the government reneging on its promise, keeping public indebtedness at its targeted limit even if there is a solid counter-argument that low private demand for debt gives it some wiggle room. It is likely that the market is anxious about a widening fiscal gap adding to extant inflation pressures bred by both domestic (food price increase) and global factors. The fear of retreating capital flow as the Fed balance sheet crunches and the central bank hikes rates is also getting priced in.
The problem is that all this is happening at growth rates that are far from optimal and pandering to the bond markets could bring new problems. Pruning the budget deficit would entail more ruthless cuts in expenditure or an aggressive tax collection drive that could have negative ramifications for growth.
For the near term, the RBI’s middle path of keeping rates on hold (as we expect it to do when it meets for its next monetary policy on December 6) and ensuring that while liquidity is on a steep trend downward, it doesn’t dry up altogether, might get the balance right.
Let’s leave you with a contrarian view. What if the hardness in bond yields is actually an indicator of the prospect of high growth (with the associated prospect of higher credit demand and so forth)? Let’s go a step further, which is that a 7 per cent yield on the 10year bond is now the critical threshold that separates expectations of accelerating growth from deceleration. Thus, if it crosses 7 per cent, the growth campers should raise a toast. If it slips below, worries of deceleration dominate.
Take your pick!