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.