The Union Budget came under the backdrop of a more challenging global environment. Developed market yields have generally been inching up reflecting somewhat better growth prospects especially in the US, hard commodity prices have risen substantially, and there has been escalation in geo-political risks. Reflecting muted capital inflows, the rupee has been under pressure despite a well -behaved current account. Local growth seems to be rebounding as well, but there is some headwind in play from escalated tariff impositions. Global capital is almost spoilt for choices between higher developed market bond yields on the one hand and AI build-out and adoption on the other.
A good way to respond to the circumstance is to keep doing what you are doing with the focus with which you have been doing it. While taking account of global challenges, the budget has largely continued along the path of constraint optimisation via focussing on fiscal credibility and expanding productive investments. The flip side, however, from the market’s standpoint is the potential near-term disappointment on the lack of any spectacular ‘reactive’ announcement to short term pressures from global macros. The same can be thought of from a bond market standpoint. The finance minister has not only delivered on fiscal commitments made before but has chosen to continue down the path of incremental consolidation as well, despite having some cover under the medium-term debt/ GDP framework going ahead. The budget assumptions look very much steady as also seen in the numbers summarised below:
Source: India union budget, Bandhan MF Research
Takeaways
With RBI being a major net buyer of government bonds over the last one year (approximately 75% of net issuances of central government securities), some small swings in the gross borrowing number in the budget would have eventually been neither here nor there. That said, and if one insists on labouring the point, the gross borrowing via dated securities at INR 17.2 lakh crores is a shade larger than consensus market expectations. This is so even after INR 1.3 lakh crores budgeted borrowings under treasury bills. Put another way, the market got its wish of some part of market borrowing being shifted to treasury bills. However, borrowing via dated bonds is still higher than expected since total market borrowing (including short term borrowing via treasury bills) as proportion of fiscal deficit has risen to 76.9% in FY 27 BE from 66.8% in FY 26 RE and 58.1% in FY 25. This is a significant jump but can potentially throw up a positive surprise as well down the line, if other sources of financing the deficit turn out to be stronger than currently assumed. However, if at all, this could be a story for later in the year and not now.
The larger story for the bond market is the push-pulls between an incrementally more adverse global macro environment exerting upward pressure on yields on the one hand, and aggressive RBI OMOs on the other. While OMOs are led by the need to ensure adequate core-liquidity buffers, the impact on term premia is nevertheless well recognised. Thus, and admittedly drivers of other curves may be somewhat different, the rise in swaps and non SLR rates have been much sharper than that in government bond yields. Unlike the general market view that bond yields need to reflect transmission better, ours is almost entirely the opposite: bond yields need to adjust to reflect changes in global macro realities, in our view. The argument here isn’t around efficacy of rate differentials in attracting capital flows in the near term, but rather the need to generally allow market forces to determine bond prices so that future volatility needn’t be as sharp when RBI isn’t the biggest buyer anymore. That said, the slowdown in FX intervention and the usage of other measures including FX swaps and (more recently) term repos, probably mean that OMO pace will automatically slow down going ahead.
As previously discussed, we continue with a conservative duration stance for now alongside some cash/ quasi cash exposures to retain portfolio flexibilities. The sharp rise in non-SLR rates is allowing for good carry opportunities. These may very well also manifest as some modest mark-to-market gains further down the year as RBI’s liquidity infusion steps bear more sustained fruits and banks’ credit to deposit ratios ease with the onset of ‘lean’ season on credit. As always, these views and positionings reflect our current thinking only and may change going forward.
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