Export focus in the govt's growth agenda

In a positive surprise, Union Budget FY2020 committed on its path of fiscal prudence, lowering its budgeted fiscal deficit to 3.3 per cent versus 3.4 per cent of gross domestic product (GDP) budgeted in the interim Budget. The markets were expecting a breach to the tune of approximately 3.6 per cent given the headwinds from both domestic and global growth on the one hand, and expectations of a counter cyclical fiscal policy to stimulate growth, on the other. However, the Budget showcased the underlying ideology of sticking to the path of fiscal prudence to avoid crowding out private investment, reflected in the unchanged expenditure targets. A shortfall in receipts is budgeted to be made up from higher customs and excise duty revenues, higher non-tax revenue including higher RBI dividend payouts, and higher disinvestment receipts. 

Apart from the headline numbers, which at the moment look feasible, the introduction of foreign currency sovereign issuances would also reduce domestic borrowing demand and is a big positive for the bond markets. Moreover, sticking to the fiscal glide path also provides monetary policy more bandwidth to continue on its path of monetary policy accommodation. With the government focused on reducing the cost of capital, and the current monetary policy committee (MPC) oriented to align itself to that goal (especially under the scenario of negative output gap and benign inflation trajectory), we expect two more rate cuts in this cycle, with the next one in August.

The equity markets were disappointed with the Budget. The expectation that populist doles would immediately kick-start consumption growth were missing. On the contrary, imposition of higher customs and excise duties on gold and petrol/diesel could further dent both urban and rural demand. The increase in shareholder limit from 25 per cent to 35 per cent and higher surcharge on FPIs, have had negative ramifications for stock market sentiment. Policies of bringing in more FDI flows through easing of FDI norms in certain sectors, bringing down public holding to below 51 per cent for PSUs and allocation towards recapitalisation of bonds, while all aimed at reducing cost of capital, have at the moment been largely ignored. Over the medium term, the increase in the available float may lead to some favourable rebalancing on MSCI equity indices which would attract flows in the long term. Other foreign investment related liberalisation steps such as increasing the statutory limit for FPI holding in a company in line with sectoral FPI limits, allowing FPIs to invest in debt securities issued by real estate investment trusts (REITs) and infrastructure investment trusts (InvITs) could help infrastructure investment in the long term. 

The watershed event that has happened in this Budget is the announcement of the government’s intent to diversify its borrowings towards foreign currency issuances. India’s external debt to GDP ratio is one of the lowest among emerging market peers with its sovereign external debt to GDP ratio at under 4 per cent. Most emerging markets have issued foreign currency denominated bonds or have conducted local currency issuances offshore. It seems to be an opportune time for India to explore the same as well. This will have multiple benefits. On an unhedged basis, the government’s borrowing costs should come down significantly as the likely spread of the Indian sovereign over London interbank offered rate (Libor) should be at approximately 100 basis point. This will also help to reduce the crowding out faced by the private sector borrowers on account of large public domestic borrowing. However, on the flip side if a significantly large issuance is done, then there could be some adverse impact on spreads of the investment grade corporates who borrow offshore. 

Apart from this, as far as the domestic IGBs are concerned, at current Mumbai interbank forward offer rate (MIFOR) levels, FPIs may choose to divert some of their holdings towards the FC issuance especially those who are hedged. For the unhedged entities there could be a case for investing in the FC bond and use the non-deliverable forward (NDF) market to exploit any onshore-offshore arbitrage. Also, any sharp currency depreciation could lead to government’s fx loss.

However, it is still a very significant move and there would be significant effective arbitrage opportunities for India dollar bond at the levels of USD-IRS and MIFOR levels prevailing now. Given that it is India’s maiden issuance, the spread over US Treasury should also be fairly attractive.  

From a market perspective, we expect bonds to trade in a range of around 6.40-6.70 per cent in the near term, buoyed by the fiscal prudence, prospects of sovereign issuance, monetary policy outlook and globally favourable environment. However, given the rather weak outlook for domestic economic growth, we may witness stress in the fiscal scenario later on in the fiscal and the government could once again have to resort to expenditure shifting or saving methods. 

We expect the rupee to benefit from a favourable external sector outlook with expectations of a balance of payments surplus worth of $20 billion, with upside risks dependant on the quantum of offshore bond issuances by the government. The prospects of the Federal Reserve easing policy is also a positive for EMs in general as the dollar index is expected to weaken on the margin. Hence, we expect a broad trading range of 68-70 for the rupee. However, from a competitiveness perspective the RBI may choose not to let the currency gain too much as there is also a strong exports focus in the government’s growth agenda. 

The author is group head, global markets, sales, trading and research, ICICI Bank



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