If you have invested in debt mutual funds or planning to buy one, this would be the appropriate time, as yields will likely stabilise with the pace of interest rate hikes slowing.
In the run-up to the Union Budget 2023-24, the market chatter was about potential changes to the long-term capital gains tax. The holding period for stocks and
bonds is one year. The market is relieved. Let’s now look at the developments from the bond market perspective.
Market Standpoint
Of the many facets of the Union Budget, the one most keenly watched by the bond market is the fiscal deficit. In every budget, the government projects the income and expenditure for the next financial year and the deficit. It also gives the estimates for funding the deficit, largely through the issuance of bonds, popularly referred to as government securities (G-Secs), for borrowings from the market. The higher the deficit, the higher the quantum of borrowing from the market, which means more supply of fresh bonds. Bond prices and interest rates move inversely; when interest rates rise, bond prices fall and vice-versa. But how does that impact you? Investments in debt mutual funds get valued daily for computing the net asset value (NAV), calculated as per the prevailing prices of the market instruments. The market price is a function of the prevailing interest rates.
So what happened in the new budget? To recap, the fiscal deficit in FY2020-21 was as high as 9.2 per cent of gross domestic product (GDP) due to big government expenditure to fight the pandemic-induced slowdown. In FY2022-23, the fiscal deficit target is 6.4 per cent. The government plans to bring it down to 4.5 per cent by 2025-26 through fiscal consolidation. Union Finance Minister Nirmala Sitharaman has outlined a fiscal deficit target of 5.9 per cent of GDP in 2023-24, in line with market expectations. The other aspect is issuance of G-Secs. The gross borrowing target, prior to maturities due in 2023-24, is T15.43 lakh crore. The market estimate for gross government borrowing varied from research agency to agency in the run-up to the budget. The positive aspect, however, is that it is lower than the median
of market expectations. The gross borrowing is slated to reduce from 5.2 per cent of GDP in 2022-23 to 5.1 per cent in 2023-24, though the absolute quantum is higher, as the GDP is growing. The bond market reacted positively to the fact that fiscal deficit and borrowing targets are within expectations. Yield levels have eased and bond prices moved up, subsequent to the announcements.
Capital Expenses
The budget reflects that the government would spend more on capital expenses. Capital expenditure to GDP rose from 1.6 per cent in 2018-19 to an estimated 2.7 per cent in 2022-23, and will increase to 3.3 per cent in 2023-24. With better producing and earning capacity, tax collections are expected to improve. Effectively, going forward, this would contribute to reducing the fiscal deficit.
Interest Rate Scenario
The repo rate, through which the Reserve Bank of India (RBI) signals interest rates in the economy, now stands at 6.25 per cent. RBI’s next meeting is on February 8, 2023. They may again hike the rate by 25 basis points (bps) to 6.5 per cent, which is expected to be the last one in the current rate hike cycle. Latest data shows inflation is at 5.72 per cent in December 2022. Post February 2023, it is expected to ease significantly.
On the same day of our Budget presentation, the US Federal Reserve increased its rate by 25 bps from 4.254.5 per cent to 4.5-4.75 per cent. Post the action, US Treasury bond yields eased. It sounds counter-intuitive. The reason is the market is looking at the end of the US rate hike cycle.
Conclusion
The Union Budget was a relevant event for our bond market. If the government’s market borrowings were on the higher side, interest rates would have moved up.
The upward trajectory of the interest rates seen in 2021 and 2022 is about to end. With stability in interest rates and consequently in bond prices, returns from debt mutual funds will be stable. High interest rates had adversely impacted returns. Now, the accrual levels of debt funds,
the interest rate accounted in the daily NA’V, are higher than, say, two years ago. It is an appropriate time for fresh investments as well. The possibility of interest rates moving up further—though it cannot be ruled out—is limited.
Source: https://outlookmoney.com/magazine/story/fiscal-deficit-target-boosts-bonds-1277