Indian debt markets will emerge “Bold and Beautiful” into FY 2023-24 post Budget 2023

Global uncertainties prevail and the European region is likely to be under the cloud of recession with high commodity & fuel prices, and US balancing between demand, unemployment, and rates.

India has stood out as a shining star, keeping its domestic growth intact and controlling inflation to a great extent.

While our concern over the current account deficit (CAD) remains, it depends on commodities and crude oil prices which add to volatility in the currency markets.

Foreign Portfolio Investors (FPIs) pulled out Rs 1.21 lakhs crore from Indian markets in the calendar year 2022. The dollar/rupee is currently hovering closer to 82, from a peak of 83.27 is a comfort.

The comfort is largely from dollar depreciation with external rate hikes shifting to normal from super-sized and with the expectation of a pause very soon.

Notably, DXY (dollar index) has reversed the bulk of its gains in the year and ~ 101.6 (as of 3rd Feb 2022) is at the levels seen in April-22 after the Fed’s first hike in March 2022 of 25 bp.The rupee has not reversed any of its depreciation, but rather range bound since the talk of the US Fed pivot.

Bank credit growth has risen to 16.5% to Rs 132 trillion during the January fortnight and is expected to pick up further as the deposit growth has gathered pace.

Banks have raised CD to meet the deposit requirements, CD issuance has seen a significant rise from RS 1.20 lakh in Jan 2022 crore to Rs 3.62 lakh crore in December 2022.

In this resilient domestic backdrop, the budget 2023 has delivered a strong message on structural growth led by capex spending and containment of revenue expenditure.

Alongside, the surprise for the debt market was a lower-than-expected borrowing programme as a portion of the maturities are funded via repayment of GST compensation loans.

The market rallied as the yields dipped by 7 basis points to 7.26% for the 10-year benchmark security. The market borrowing programme will be front loaded during the first half of the financial year.

While keeping in tune with the global rates, the US is expected to hike the rate by another 25 to 50 basis points before a long pause.

The domestic market expects a 25-basis point hike, and this will basically curtail the rupee volatility and dollar outflows.

This will keep the rates at elevated levels for the first half of the FY 2023-24 as markets at the current levels are not pricing in the risk of liquidity fading away with credit offtake and RBI’s support being limited in the context of a liquidity withdrawal stance.

The benchmark yield will range from 7.30% to 7.65%, SDL spread will range from 35 to 45 basis points over the relevant underlying security for the first half of the financial year.

As banks’ transmission of rates takes effect, we expect corporates to increase their bond issuances and the resultant corporate spreads are likely to increase to 45 bps from the current 30 bps.

The spread for PSU and manufacturing entities will widen in the 40-50 bp range while NBFC issuers spread may rise to 65-75 bp.

In the current budget’s announcement on MLDs and bonds’ taxation changes, viz. MLDs being taxed at par with debentures (vs equity earlier) and TDS on listed corporate bonds (vs no TDS), investors could shift their money to mutual funds.

However, the shift may not impact the yield dynamics meaningfully as the same bonds instead of being held by retailers will be held by mutual funds.

It could also be beneficial as issuers will get the option to issue larger-sized issuances in one lot.

The second half of the financial year will remain more interesting for bond traders, which may see a reverse of the situation and move towards a lower yield regime once again as talks of rate cuts emerge heading to the next year.

Furthermore, with a reduction in supply, plus the expectation of global stability will see a return of flows, the currency market could become more stable.

In addition, we could see a return of FPI investors into the debt market as the interest rate differential becomes attractive. These investors have been absent in the debt market since the onset of the pandemic.

A return will be positive for bond markets. The journey in the upcoming financial year is expected to be less painful and more predictable, unlike this year.

Not just India’s budget, but India and Indian debt markets will also emerge “Bold and Beautiful” into FY 2023-24.

(The author is Head-Fixed Income, Equirus)

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