“We have spent, we have spent and we have spent” said the Finance Minister on Budget Day, and the Economic Times chose to run with this quote for their front-page headline. I’m sure you’ve read a lot of articles on the Budget about how much we have spent and where we have spent, so I won’t go into all of that too much.
For me one of the striking aspects of the Budget was that after a long, long time the government was actually willing to say with almost no half measures that WE WILL SPEND for all that’s needed. We will also cut out our financial shenanigans (iski topi uske sar like we’ve done before), and not try to hide our spending. Economic growth for us is paramount, and that’s going to be our main weapon against the fiscal deficit in the future.
Of course, it doesn’t say so in as many words, but that’s probably how the markets are reading it. And boy did the stock market love it.
Sure, stock markets aren’t the best barometer of how good or bad a Budget really is — they love the idea of a loose fiscal regime and low interest rates.
But what about the bond market? Well…hold that thought for a moment.
Let’s just take a step-back. Now, we all know this is a very peculiar time indeed — what with the once-in-a-century pandemic and all. But it also means that for once, governments across the world will be facing the same unified problem of reviving their economies, while reining in ballooning debt burdens. Even the IMF had recommended that countries should do whatever it takes to revitalise their economies.
Separately, the whole stopping and starting of global supply chains has brought back something that has been missing for many years. Inflation. We in India aren’t strangers to inflation at all — but developed countries surely are. Commodity prices have soared across the world — steel, copper, oil, lead , aluminium, semiconductors, silver — you name it. This is stoking inflation.
Both elevated fiscal spending and inflation make the bond market demand higher yields (rates) on bonds.
But what if we could get someone to keep interest rates low?
Let’s just suppose that somehow central banks across the world could be convinced to keep interest rates low for a while — even if inflation and deficits stay elevated. Central banks across the world could do so by keeping the supply of money (liquidity) in large surpluses and standing up to buy bonds from the market whenever needed. Even so, this by no means is an easy task.
In such a case, governments could use their high economic growth (post pandemic) to lower their debt burdens in the future. If countries kept interest rates low in isolation, sure there’d be hue and cry of manipulation. But if everyone’s going to be doing it, no one should complain right?
But is any such thing really happening in the bond market?
The bond market wasn’t as much a fan of the Budget as the equity market. Yield on the Indian Govt’s 10-year benchmark G-sec was up ~20bps this Budget week alone.
But doosre end mei RBI bhi khadaa hai. RBI is the single largest player in the G-sec market, and the manager of the government’s debt.
At its monetary policy announcement on Friday, RBI made no change to the repo rate and retained its ‘accommodative’ stance, even as it raised its inflation outlook for next year. Shortly afterwards on Friday itself, the RBI conducted an auction of some long-tenor G-secs where it promptly refused all bids for bonds from market participants. This is a signal from the RBI that the yields demanded by the market are too high, in its view. This isn’t a common occurrence at all, but its something that has happened quite a few times over the past 6–7 months
What normally follows is that the RBI will probably buy G-secs from the open market to bring yields down. The RBI seems to be batting to keep 10-yr yields at 6.0%, no matter what. At least for now.
The RBI isn’t an outlier in any sense in trying to keep rates low either. The Fed too seems to have signalled that it doesn’t want to tinker with interest rates or cut down on its bond-buying any time soon.
So does that mean that we are headed into a regime of loose fiscal policy coupled with low interest rates? Stock markets love that stuff.
Let’s see where this goes. Until next time! :)