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India's sovereign bonds market has been jittery of late, with investors bracing for the government to announce populists measures in the union due this Friday. Bank of America Merrill Lynch isn't perturbed.
Bonds are poised to rally as fears about fiscal slippage are overdone and the central bank will likely start easing policy as early as next week, said Jayesh Mehta, who in August correctly predicted the end to the selloff in local bonds.
Markets will be positively surprised on the fiscal front, Mehta, the country treasurer at the bank said in an interview in Mumbai.
The yield on the most-traded 2028 bonds has risen in four of the past five weeks as Prime Minister Narendra Modi's administration prepares an aid package to appease farmers, a key voting block, ahead of elections due by May. The size of the relief measure has been the subject of intense speculation, with the additional expenditure varying from about ₹70,000 crore ($9.8 billion) to as high as ₹3 lakh crore.
The concerns about the health of India's finances have coincided with a rebound in prices of oil - India's top import - and below-average revenue from goods and services tax and asset sales. A drop in oil prices in the final three months of 2018 and purchases by the Reserve Bank of India had helped bonds log their best quarter in four years.
The government will meet its fiscal deficit target of 3.3% for the year ending March, while it may slip marginally from next year's 3.1% aim, Mehta said. Any deviation will be met from additional revenues and by way of a higher dividend from the RBI, he said.
"The track record of this government shows it has been fiscally prudent. I don't see why it would splurge and spoil it in its last year," he said.
To be sure, this fiscal year's 3.3% target was widened last February from the previous 3% aim. The budget deficit, on the other hand, is seen edging higher to 3.5% of GDP this year versus the 3.3% target, according to a separate Bloomberg survey.
It's not the first time Mehta, 55, has bet against market consensus. He correctly predicted the RBI would lower rates in 2017, when practically everyone was expecting a hike. Last August, he called time on the surge in benchmark yields.
Now, he expects the central bank to roll back two hikes from last year that together added up to 50 basis points because of slowing inflation. That's as a Bloomberg survey shows the policy rate remaining unchanged at 6.5% for the March quarter. The RBI's rate-setting panel is due to announce its decision on Feb. 7.
Yields could drop another 50 basis points by end-March as the central bank's debt purchases should continue in February and March, he said.
"Even if the pace of OMOs decline, I expect ₹35,000-40,000 crore each in February and March, which should bring down yields," he said.