The fact that the fiscal deficit in the year ending March 2021 would be significantly higher than previously budgeted was a foregone conclusion. In the Budget last year, Finance Minister Nirmala Sitharaman had projected a fiscal deficit of 3.5 per cent for 2020-21. But that was before COVID-19 hit. The pandemic that led to a near total lockdown for over two months hit the economy hard, required the government to spend big and not worry too much on the fiscal deficit.
But, what clearly surprised the market was the extent the government has allowed the fiscal deficit glidepath to slip as it lays emphasis on huge spending on health and infrastructure to boost the economy.
For 2020-21, fiscal deficit has been pegged at 9.5 per cent of the GDP, while it is estimated to be 6.8 per cent of GDP in 2021-22.
The higher than expected fiscal deficit projection for next year and additional market borrowing of Rs 80,000 crore over the next two months shot up bond yields and the benchmark ten-year bond yield touched 6.10 per cent at one point.
“To ensure that the economy is given the required push, our BE estimates for expenditure in 2021-2022, are Rs 34.83 lakh crores. This includes Rs 5.54 lakh crore as capital expenditure, an increase of 34.5 per cent over the BE figure of 2020-2021,” said Sitharaman.
The gross borrowing from the market next financial year is estimated to be around Rs 12 lakh crore.
“The fiscal deficit of 6.8 per cent of GDP for the next financial year and additional borrowing of Rs 80,000 crore in the current financial year is clear negative for bond markets,” said Murthy Nagarajan, head of fixed income at Tata Mutual Fund.
Analysts note that the huge borrowing target suggests a busy year for bond issuances and that will put upward pressure on bond yields. Nagarajan sees 10-year bond yields moving towards 6.25-6.50 per cent range if the RBI doesn’t aggressively intervene in the bond market to bring down the yields.
“The government has clearly prioritised investment-led growth over fiscal consolidation. This spells good news for the economy as well as the equity markets. On the other hand, debt market may find the high market borrowing a little too daunting and may look up to the central bank to contain any sharp volatility in yields,” said G Murlidhar, MD and CEO of Kotak Mahindra Life Insurance Company.
Arvind Chari, chief investment officer at Quantum Advisors, says that it was good to see the government focus on reviving growth and the equity markets had reacted to it. “However, it (the higher fiscal deficit target) came as a shock for the bond market,” he says.
“No one expected that Prime Minister Modi will agree to shed his fiscal conservatism to such an extent,” he said.
According to Chari, bond yields have bottomed out and the best of the returns from long bond funds may be behind us.
India’s Fiscal Responsibility and Budget Management (FRBM) Act mandates that revenue deficit, fiscal deficit, tax revenue and the total outstanding liabilities must be projected as a percentage of the GDP in the medium-term policy statement. The set targets could be exceeded only in case of a calamity or national security issue. Analysts had agreed that in the wake of the pandemic, FRBM would be best left on the sidelines this year and the government would rather focus on measures to lift the economy.
The challenge now for the government is to ensure that it not just revives economic growth in the coming years, but also gets the medium term fiscal deficit on the right path.
Sitharaman said the government intended to continue with its path of fiscal consolidation and intends to reach a fiscal deficit level below 4.5 per cent of GDP by 2025-2026.
“We hope to achieve the consolidation first by increasing the buoyancy of tax revenue through improved compliance, and secondly, by increased receipts from monetisation of assets, including public sector enterprises and land,” said Sitharaman.
“This increase in spending over the next four years needs to revive growth back to at least 7 per cent level. If that happens, then the higher deficit will be forgiven. If not, high inflation and high deficits can cause macro instability in the years ahead,” warned Chari.
