A Rs 1.45 trillion tax cut may undermine rate reductions in India

Topics Nirmala Sitharaman | RBI

Finance Minister Nirmala Sitharaman along with Minister of State Anurag Thakur at a press meet in New Delhi | PTI
India’s $20 billion tax-cut boost may have an unintended effect of keeping borrowing costs high.

The premium of 10-year yields over the central bank’s policy rate widened to the most since April after the surprise stimulus announced Friday raised fears the government will miss its budget deficit targets. Traders say the spread offers lenders little incentive to pass on past interest rate cuts to customers.

“Why would a bank take credit risk when they can simply borrow from the Reserve Bank of India and invest in a government bond and just sit on it,” said Vijay Sharma, executive vice president for fixed-income at PNB Gilts Ltd. in New Delhi.

While the central bank has cut rates four times this year, banks have been reluctant to fully pass on Asia’s most aggressive easing amid a surge in bad loans. The widening spread reflects worries about the government adding to its record borrowing after the major booster.

“A high term premia, together with wider credit spreads, would mean that interest rates for end-borrowers will remain high despite steep rate cuts of 110 basis points announced this year,” Neelkanth Mishra, India strategist at Credit Suisse Group AG, told BloombergQuint.

While Finance Minister Nirmala Sitharaman said there were no plans to revise its borrowings of Rs 7.1 trillion for now, traders remain cautious. Standard Chartered Plc is forecasting the need for as much as Rs 800 billion ($11.3 billion) of new debt.

The tax cut, estimated to cost Rs 1.45 trillion in lost revenue, may push up the fiscal deficit to 3.9% of gross domestic product for the year to March, compared with a goal of 3.3%, according to a Bloomberg poll of economists.

Yields on 10-year bonds surged as much as 24 basis points on Friday, the most since February 2017, and a gauge of volatility for the notes rose to an eight-month high. They fell 4 basis points on Monday to 6.75%.

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