This can raise India’s potential long term growth rates. We believe that follow-up and efficient execution of the budget proposals can should lead to revival of animal spirits in the economy and unleash the next big structural growth phase for India. The key positives of the budget are that it is a Growth oriented budget which clearly focuses on spending for revival. In that sense, there is a robust pick up in capex expenditure vs revenue expenditure. While capital expenditure spending will be back ended, it will result in more structural and strong growth in the medium to longer term. Other than that, the estimates are realistic and credible in its revenue projections especially tax revenue (FY22 growth is only ~10% compared to FY20). Also GDP growth projections are conservative at 14.4% especially after a period of decline. While it lends strong credibility to the budget numbers, it also leaves the room open for positive surprise in the future. The budget focuses on Improving fiscal transparency with on boarding of significant past off-balance sheet borrowing on books. And budget also focuses on the cleaning up act across, not just with the fiscal numbers, but the intent to set up an ARC to support a clean-up of the banking is welcome, especially at the time when banking system has not warming up to credit growth despite rate cuts from the RBI.

From market perspective, the key negatives of the budget are that of higher than expected fiscal deficit: Fiscal deficit at 9.5% for FY21 and 6.8% for FY22 along with a glide path of less than 4.5% by FY26, have been higher than expectations. Expansionary budgets in addition to higher borrowing, also raise inflation concerns. With the fiscal consolidation path for both center and state pushed until FY26, heavy government borrowing until medium term is a cause of concern for domestic markets. This is not just a question of absorption of the supply, but also could potentially crowd out private borrowing for capex, when the intention is to push capex. Also, with respect to the External rating pressures, a weak fiscal position could pose a credit challenge when compared with global peers. Note that all there major global rating agencies, S&P, Moody’s and Fitch have the lowest investment grade ratings at BBB-/Baa3 for India. Among the three Moody’s and Fitch have a negative outlook while S&P has a stable outlook.

Q . What impact will the budget have on the bond markets, especially given the fiscal deficit projected at 6.8% for next year and 9.5% for the current FY? Please comment on the borrowing plans of the government. How do you think will it impact the yields in the market?

Answer : Markets have reacted negatively post budget as the deficit and borrowing numbers was clearly way above expectations. In terms of the borrowing plan - 61% of the total deficit is expected to be market borrowing via bonds which translates into INR 12 trillion of gross borrowing of government securities. Despite much of the expansion being constructive in nature, it was hard for the markets to digest that and markets reacted severely negative on the budget day. Post that all eyes were on RBI policy for the direction and relief.

While the much awaited post budget policy delivered on all the required parameters, a powerful counter narrative to offset market concerns on the heavy borrowing program was missing. Also market was expecting definitive guidelines on liquidity such as OMOs which was not announced in the policy. The statement that CRR normalization opens up space for a variety of market operations to inject additional durability liquidity also did not comfort the markets. Perhaps market interpreted the absence of a concrete policy action on liquidity and borrowing program as a negative and yields hardened further.

However, we would think that all is not lost. RBI was keeping its tone balanced given the inflation risks and will deliver and support markets as done in the past. On the liquidity front, we expect RBI to remain accommodative and use its combination of conventional and unconventional tools to keep adequate liquidity to support the borrowing program as well as credit growth. Also on the growth – inflation dynamics, preference for growth will remain at least for the next 6-12 months, until there is a strong visibility that growth has steadied. On these counters, one could see a range bound activity and a mild reversal in yields in the near term.

Q . The budget has proposed the formation of an Asset Reconstruction Co. and Asset Management Co. for managing stressed assets. What does this mean for the bond markets?

Answer : Formation of an independently managed ARC is a positive structural change as it removes the burden from banks to sit on the resolution table with an independent ARC manager. The pooling of stressed assets can lead to faster resolution and better recovery rates for lenders Again, since the capital will be infused by the banks and not government, government will have a limited role to play in the resolution process and thereby adding to the transparency of the resolution process. For the bond markets, it means faster resolution of stressed debt thereby improving overall risk appetite. This should provide constructive for credit growth going forward.

Q . What investment strategy are you following for your flagship funds? Is there any change in the strategy post-budget?

Answer : Post budget we intended to maintain a neutral to underweight stance in the portfolios. We retain this view post RBI policy. Citing liquidity, we would retain a constructive view on the rates eyeing the front part of the curve with a carry view. Medium and longer end of the curve, will see much of the volatility and pressure as the additional borrowing for the next two months is positioned in the space. We would however expect our position and strategy to remain flexible during the course of the year. RBI’s positive intervention could be a key driver of rates. Alongside, with bulk of the budget news now priced in we see that several supplementary factors (inflation data points, currency, oil price movements, external rate factors) playing a dominant role going forward, which would dictate our strategy going ahead.

Q . What would be your advice to a moderate/aggressive debt MF market investor, hoping to generate 'real' returns over a 1-year and a 3-year investment horizon?

Answer : Investors positioning and investment in the market is more a function of their asset allocation and risk appetite. While short-end funds tend to do well with respect to consistency and volatility, their ability to generate return in a falling interest rate regime is limited. Similarly, while Long duration strategy tend to be higher in terms of volatility, hence are categorize are relatively risky, their ability to generate capital gain is much higher in environment when interest rate moving down. But I reckon that timing the market and moving from one category to other in different cycle is not possible for investors. For now, we expect the market segment across the curve and specially the front to medium part to offer attractive carry options. With the overnight remaining close to reverse repo (currently at 3.35%), and expectation of a steep yield curve, we expect the risk reward ratio to be favorable at those points in the curve. As such, the short/medium duration products with cautious stance seems apt.

Source: Data as at 31 Jan ’21 unless otherwise given.

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