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The Bull Case

Over the last two years, bond markets endured a historic jump in global inflation, fastest ever rate hikes by central banks across the globe, wild swings in commodity prices and intense geopolitical stress unseen in decades. The US treasuries, which are widely perceived to be risk-free asset, have been behaving like a penny stock with sharp moves in yields.

Amidst all the chaos, the Indian bond market has shown an unshakable resilience. Indian bond yields remained relatively stable trading between 7.0%-7.5% for most of this period. Credit spreads remained tight, and demand for bonds remained robust. Even foreign investors were buying Indian government bonds despite elevated interest rates around the globe.

There are still many reasons to be positive on the Indian bond market going forward.

The Core Disinflation

The headline CPI inflation has been all over the place lately due to volatile food prices, mainly due to vegetables. From its peak of 7.44% in July 2023, it has now come down to a more comfortable level of 4.9% in October 2023.

However, a more significant disinflation has been witnessed in the Core CPI Inflation which excludes the volatile food and fuel index. Historically, the Core CPI have been more durable in nature – often showing the underlying inflation trend in the economy.

The Core-CPI has come down consistently since start of the year from over 6% in January 2023 to 4.27% in October 2023. Based on the current trend and general weakness in the broader demand outlook, the core CPI might fall further towards 3.8% by mid of next year. This should offset any potential upside move in food prices due to fall in agricultural production – keeping overall consumer inflation under check.

Chart – I: Falling Core Inflation (ex-Food and Fuel) to ease pressure from the RBI

Fiscal Flexibility

Government’s tax collections have shown a healthy growth in the first half of the fiscal year 2023-24. As per the government’s press release, direct tax collections for FY24 up to October 9, 2023 have grown by 21.8% compared to same period last year. This is significantly higher than the government’s budgeted direct tax growth target of 10.5% YoY.

Chart – II: Tax Revenues continue to grow at a faster pace than budget estimates

Non-tax revenues have also shown a remarkable jump over the last year owing to the large dividend of Rs. 874 billion from the RBI. We expect other public sector companies particularly public sector banks to also deliver reasonable growth in dividend payouts to the government this year.

In our estimate, combination of tax and non-tax collections could provide government around Rs. 1.5 trillion extra revenues than their budget estimates. Even after adjusting for some shortfall in the disinvestment target, the government will likely have more than Rs. 1.2 trillion of extra cash this year. This can be used to reduce taxes on fuel or increasing welfare spending without stretching the government’s fiscal position. This also opens a possibility of reduction in government borrowing later in the year.

Collections under various small saving schemes of the government have also shown a robust 50% increase during April-August 2023 compared to the same period last year. This further boosts the chances for reduction in government borrowing.

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