Introduction
As the
date for the presentation of the Union Budget approaches on February 1, 2025,
anticipation grows among various demographic segments, each holding their
distinct expectations. This analysis explores the perspectives of bond
investors, who play a pivotal role in the financial markets. With a focus on
fiscal policies and market dynamics, this article aims to outline the potential
impacts and considerations for bond investors as they approach the upcoming
fiscal announcements.
Fiscal Deficit's Impact on Bond Markets
For
equity investors, the Union Budget has implications across a multitude of
industries and segments. For bond investors, however, the focus is primarily on
one pervasive parameter impacting the market: the fiscal deficit target for the
next financial year. Let's explore the reason this variable has such a high
impact.
The
government runs a deficit every year—they spend more than they earn. This
deficit is largely bridged by borrowings from the market, primarily through the
issuance of government securities (G-Secs). The government is the largest
borrower and issuer of bonds, followed by the corporate sector. Naturally, the
higher the fiscal deficit, the greater the issuance of G-Secs, and vice versa. Changes
in the fiscal deficit, whether decreasing or not, as a percentage of GDP, have
potential implications for the market. Market dynamics such as supply, and
demand can affect bond prices and yield levels. Additionally, a high fiscal
deficit is pro-inflationary, which negatively impacts markets. Thus, easing the
deficit is desirable for both reasons.
Expected Trends in Government Borrowing and Fiscal Health
It is
anticipated that discussions in the forthcoming budget might include government
strategies regarding the fiscal deficit. In the Covid-stricken year of 2020-21,
the deficit was 9.2% of GDP. Since then, it has been decreasing. For 2024-25,
the estimate is 4.9% of GDP. The government has indicated that for 2025-26, the
deficit target will be 4.5% of GDP. Given that the government's finances appear
healthy, driven by buoyant tax collections, market analysts often examine
potential governmental fiscal targets and their implications. For instance,
adjustments to the fiscal deficit as a percentage of GDP could be considered,
but it's crucial to review these in conjunction with other economic data and
trends. In the current financial year, the issuance of G-Secs is budgeted at Rs
14 lakh crore (INR 14 trillion) and, net of redemptions, it is Rs 11.6 lakh
crore (INR 11.6 trillion). The estimates for the next year will be delineated
in the budget. While the fiscal deficit as a percentage of GDP is expected to
decrease, given that our GDP is growing and the size of the budget is
increasing, the quantum of market borrowing remains a critical variable for the
bond market.
Taxation Changes and Their Implications for Bonds
Another
potential variable in the budget, which may or may not change, concerns
taxation rules relating to bonds. To recap, certain changes were made in the
previous Union Budget presented on 23 July 2024. Long-term capital gains (LTCG)
taxation on listed bonds for a holding period of more than one year was
increased from 10% to 12.5%. The rule for unlisted bonds changed as well;
previously, unlisted bonds held for more than three years were eligible for
LTCG, taxable at 20%. Now, unlisted bonds are taxable at the marginal slab
rate, irrespective of the holding period. Further back, taxation of
market-linked debentures (MLDs) changed to the marginal slab rate, which was an
adverse move for investors. Speculation is in the air that the Finance Ministry
may consider a complete overhaul of personal income tax rules, which may
benefit retail taxpayers. However, one should not speculate and instead wait
for the event.
Corporate Bond Issuances and Budget Linkages
Regarding
corporate bond issuances, there is no direct linkage with the Union Budget. The
indirect linkage exists if there is any incentive for corporations to build
capacities; they may need resources for capital expenditures (capex). For this,
apart from issuing equities and obtaining bank funding, they would issue bonds.
For investors in corporate bonds, the bigger impact is of the prevailing
interest rate regime and corporate health.
Conclusion
As the
presentation of the Union Budget on February 1, 2025, draws near, a variety of
market sentiments are likely to surface. It is advantageous for investors to
remain well-informed and adopt a comprehensive view of possible outcomes. While
expectations about government borrowing and fiscal policies can shape market
conditions, these are ultimately contingent upon the actual measures enacted
and prevailing economic trends. Although projections indicate a potential
increase in government borrowing for the fiscal year 2025-26 compared to
2024-25, the growing demand from financial entities such as banks, insurance
companies, pension funds, and corporate treasuries, along with anticipated
inflows from Foreign Portfolio Investors (FPIs), may counterbalance this
effect. Nonetheless, as market conditions can swiftly shift, investors are
encouraged to exercise caution and diligently assess the risks and unforeseen
variables that might impact market stability and returns.
Disclaimer - Investments in debt securities, municipal debt securities / securitised debt instruments are subject to risks, including delay and/ or default in payment. Read all the offer-related documents carefully.
