Fiscal slippage fears come true – bonds react, equities hopeful.

By Gaurav Kulshreshtha | 03 JANUARY 2018

  • Last week finance ministry announced the decision to increase its market borrowings program for the current fiscal by an additional INR 500bn (0.3% of GDP) over and above the budgeted net borrowing of INR 3482bn, through dated government securities. This announcement comes on the back of recent tabling of 2nd Supplementary demand of grants (net cash outgo of INR 334bn), soft trends in GST collections (Q3FY18 avg. monthly collection at INR 821bn vs INR 917bn in Q2), and fiscal deficit reaching 96% of full year budget estimates in Apr-Oct period itself (possibly headed to 100% of budget estimates in Apr-Nov).
  • The last time government resorted to extra borrowings was in FY2012 (~INR 900bn of additional borrowing), owing to which the fiscal deficit had slipped to 5.9% of GDP, from the budgeted 4.6% of GDP. Thus after five years of fiscal prudence and consolidation, the specter of extra borrowing and fiscal slippage has returned.
  • While Citi economists had anticipated a fiscal slippage of about 0.3% of GDP, however they noted that the government could have either utilized the excess small savings collections or used other financing sources such as drawdown of its cash balance/unallocated IGST collections, rather than resorting to additional bond issuance given difficult market conditions. Thus this additional borrowing announcement comes as a negative surprise to them. This also shifts their expectation of the benchmark 10yr yield to 7-7.35% range from 6.9-7.25% earlier.
  • Earnings Yield Gap (10yr G sec yield- Sensex Earning Yield) now at 1sd above 10yr mean.

    Source: Bloomberg

  • The 10yr g-sec yield has spiked by almost 80-90bps to 7.35% in the last couple of months, equity valuations however have edged higher, depressing the earnings yield further. Consequently the Earning Yield Gap (10yr G sec yield- Sensex Earning Yield), which was quite attractive until about a year ago, has worsened and is now at 1sd above long term mean.
  • Earnings growth would be the key driver of returns going forward.
  • Indian equities have rallied ~28% in 2017 largely driven by strong flows. However, given the reported earnings trends (downward revisions), valuations (1sd above long term mean) and more signals (Citi India Sentiment Indicator remains elevated, suggesting modest 12m forward returns), Citi analysts see limited upside.
  • Basis Citi analyst views, in equities we prefer large-caps over mid-caps and in debt we continue to avoid fresh long duration exposure. Investors should maintain asset allocation in their portfolios in line with their stated risk tolerance and avoid any concentrated exposures.

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