Bond investors worried as weak Modi victory fans fiscal populism fears

By Subhadip Sircar, Khushi Malhotra and Malavika Kaur Makol

A smaller-than-expected poll victory for Prime Minister Narendra Modi is leading to worries among bond investors about greater populism.
 

Fiscal discipline has been a hallmark of Modi’s decade-long administration, and many investors were expecting him to win a supermajority to reduce the budget deficit and further cut government borrowing in the next budget. 

The election results stunned traders and led to a selloff in Indian assets on Tuesday. Stocks saw their worst day in four years, bond yields rose the most since October and the rupee hovered near a record low. ICICI Prudential Asset Management closed a tactical bond exposure call on the 10-year government note on the possibility of a populist budget after the election results, it said in a note.

 

Modi’s Bharatiya Janata Party will fall short of a majority and will need its pre-election allies to form a government, the results showed. The coalition is way short of the 350-seat mark most exit polls had given the alliance. 

“There is fear that more populistic measures could be undertaken, more spending can happen, fiscal consolidation can be under stress — so all these kinds of fears are arising,” said Sandeep Bagla, chief executive at Trust Mutual Fund. 

Modi will face a series of crucial state elections in the coming months including Maharashtra, Haryana and Delhi.

Strong revenues and a slowdown in spending during elections has led to a large government cash buffer. Moreover, a bumper dividend of $25 billion from the central bank, nearly double market estimates, had given rise to hopes that the new administration may use a part of the proceeds to further cut its Rs 14.1 trillion ($169 billion) bond borrowing plans for the current year.

The administration has already lowered its shorter-term borrowings by Rs  60,000 crore for the quarter and there were growing expectations of a cut in budgeted borrowings. It has also announced a series of bond buybacks to take advantage of the cash position.

Benchmark yields had slid below 7 per cent to an over two-year low before surging back above that level on Tuesday. India’s strong growth as well as inflows ahead of inclusion to JPMorgan Chase & Co’s flagship emerging bond index have helped support the market. Yields are unlikely to fall much more, according to ICICI Prudential.

Amidst the election volatility, investors are also readying for the Reserve Bank of India’s rate decision on Friday, where it is expected to stand pat.

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Modi now needs to secure the support of two key members of his broader National Democratic Alliance who control some 30 seats — enough to flip the balance of power in parliament. Leaders of those two parties have a history of switching sides and only joined up with Modi a few months ago, making it unclear whether they will stick with him or back the opposition bloc.

“Bond markets will look at which parties constitute the government that is formed for next cues, as fiscal consolidation might take a backseat with the government leaning toward populist measures,” said Sandeep Agarwal, head of fixed income at Sundaram Asset Management Co. “The market may not want to price in a cut in borrowing currently.”

The base case is for the government to stick to a medium-term fiscal consolidation roadmap but with a populist bias, UBS economist Tanvee Gupta Jain wrote in a note. The higher-than-expected dividend transfer to the government would create fiscal leeway to increase populist spending to support consumption for lower income strata while continuing its thrust to boost public capex, she said.

“With realigning expectations of fiscal spending, the government bond steepening theme should still work well,” said Madhavi Arora, lead economist at Emkay Global Financial Services Ltd.