Prime Minister Narendra Modi speaks in the Rajya Sabha. | PTI
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Mumbai: It turns out that bond traders in India can be forgiving of budget misses when economic growth is threatened.

Prime Minister Narendra Modi will widen the budget deficit target to 3.5% of gross domestic product on Friday, up from a February estimate of 3.4%, according to the median forecast of 10 traders and analysts in a Bloomberg News survey. While there may be a knee-jerk reaction in markets, it won’t derail India’s nascent bond rally, they say.

Traders say Modi has room to loosen the purse strings as inflation is subdued, an outlook shared by the Reserve Bank of India when it cut rates for a third time this year in June. The most aggressive policy easing in Asia has supported a rally in bonds and lured foreign inflows of $1.2 billion last month.

“The fiscal situation is not worrisome,” said Mahendra Jajoo, Mumbai-based head of fixed income at Mirae Asset Global Investments. “The slight adjustment in the deficit target will be mainly on the back of tempering growth expectations.”

The yields on benchmark 10-year bonds may drop to as low 6.25% by the end of the year, according to Jajoo. They have declined more than 50 basis points since the end of April to close at 6.88% on Monday.

One reason why bond traders are sanguine about any deficit misses is the expectation that the central bank will maintain its policy stance and continue with debt purchases.

“A higher fiscal deficit will take some sheen off the rally but if the RBI remains accommodative and uses open-market purchases, yields will remain supported,” said Arvind Chari, head of fixed income & alternatives at Quantum Advisors in Mumbai. Chari expects the deficit to be raised to 3.7%, the upper end of forecasts in the survey.

Traders also expect gross government borrowings to be kept largely unchanged at 7.1 trillion rupees ($103 billion).

Also read: Modi’s new budget key to unleashing Indian economy’s animal spirits


Growth Stutters

The economy expanded 6.8% in the 12 months to March, the slowest in five years, and HSBC Holdings Plc expects it to grow at the same pace in the current fiscal year. The pain could worsen if a weak monsoon season — rainfall was a third below average in June — depresses rural incomes.

“This warrants a fiscal response,” said Kapil Gupta, an economist with Edelweiss Securities Ltd. in Mumbai. “Historically, a fiscal push supported by monetary easing has lured rates lower.”

Spurred by the growth risks and a dovish turn by the U.S. Federal Reserve, the RBI reduced the repurchase rate to a nine-year low of 5.75%. With inflation likely to stay below 4%, the central bank’s medium-term target, brokerages including Barclays Plc have penciled in a fourth 25 basis-point cut in 2019.

Investors are also counting on an increase in dividend and a transfer of funds from the RBI’s excess reserves to hand Modi extra revenue. A panel to decide on sharing of the reserves will probably meet after the budget announcement.

“Some significant transfer from RBI may very well be needed during the year if budget overshoots are to be avoided,” said Suyash Choudhary, head of fixed income at IDFC Asset Management Co.

Also read: Maharashtra poll-year budget big on memorials: One for Vajpayee, and another for Shivaji


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