>Impact of the budget 2012 on bond yields

We think the budget will likely be marginally positive for bond yields. Our calculations show that the general government borrowing requirement in FY13 can be financed through growth in bank deposits, insurance, mutual, and pension funds. We assume that the government may allow a further US$5 bn of investment by foreign investors in government securities. We also assume that the RBI may do OMOs of the order of Rs300 bn (US$6.3 bn), less than a third of the OMOs in FY12. That said, current long-end bond yields are being artificially depressed due to the large OMOs at the long-end that the RBI has conducted, and would have been higher otherwise. Therefore, we think some fiscal consolidation, and monetary easing at the short end should lead to a steepening of the yield curve. We forecast 10-year bond yields to be in the 7.75%-8.00% range for FY13.

Risks to our expectations

The risks to our expectations of fiscal consolidation come from higher oil prices impacting fuel subsidies, higher phosphate and potash prices impacting fertilizer subsidies, and the economic slowdown persisting into the majority of FY13. Further, an early implementation of the Food Subsidy Bill could further expand the deficit.

The upside on fiscal consolidation comes from larger privatization receipts, including the reauctioning of 2G licenses, greater buoyancy in tax revenues, and a quick pass-through to consumers of higher oil prices—particularly in diesel and LPG. We assess the risks to our fiscal deficit and market borrowing targets for FY13 to be balanced at this stage.

Cross-country comparisons suggests that fiscal consolidation is an imperative

India’s general government fiscal deficit is one of the highest among growth markets. This is largely due to a low tax base, rather than too much spending. Hence, it is imperative that the government increase the tax-to-GDP ratio, and there are low-hanging fruits in increasing revenues. While we expect the FY13 budget to begin fiscal consolidation, we do not envisage the tough, structural reforms that are necessary to lead to a sustainable increase in the tax-to-GDP ratio. These would comprise broad-basing the tax regime, implementing the Goods and Services Tax, and improving tax administration to reduce the extent of the underground economy.


To read full report: BUDGET 2012

RISH TRADER