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The Irony of India's Bond Market
Nov 21, 2017

International rating agency, Moody's, recent rating upgrade has boosted India's investment outlook. India's sovereign rating was upgraded from Baa3 to Baa2 after a gap of nearly 13 years. This arrives on the backdrop of a string of economic reforms expected to improve the business climate in the country.

Factors such as the move towards a formal economy through the Goods and Service Tax (GST) regime, growing financial inclusion aided by notebandi and rising digital transactions, government's strong thrust on resolving the bad loan mess through bank recapitalisation, and enactment of the Bankruptcy and Insolvency Act are all seen as enhancing the country's growth potential and mitigating the risk of default in government debt.

It's pertinent to note that India's public debt is mostly funded internally. While scheduled commercial banks, insurance companies, provident funds, and RBI invest in 85% of the government bonds, there is a miniscule 4% participation by the overseas investors. Therefore, the rating upgrade has come in a bit late. What is ironical is that despite a benign business environment, the bond yields in India have been ascending. Since the global financial crisis, India's bond yields have firmed up by a whopping 1.7%, putting it in line with countries like South Africa and Russia whose economies are in a state of mess.

In the short term, India's fiscal deficit is likely to remain high given the initial revenue losses due to GST, higher public spending on infrastructure, and the recapitalisation program for state-run banks. But in the long run, the economic reforms are likely to strengthen the economy and drive growth. Moreover, the government remains committed to long term fiscal consolidation. Given Moody's thumbs up, its high time that bond markets desist from childish behaviour and adopt a rational long-term view of the country's fiscal situation instead.

Data Source: SBI ECOWRAP

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