Rupee rallies, but bond yields spike

Mumbai: While the stock market and the rupee cheered the government’s decision to cut the corporate tax rate to 25 per cent on Friday, the bond market reacted negatively to the news as the revenue forgone due to the tax rate reduction would lead to a rise in fiscal deficit. Experts said that the bond market would closely watch out for the borrowing calendar in the coming week to gauge the borrowing impact and the sustained pressure on government bonds.

The rupee settled 37 paise higher against the dollar at 70.94. The local currency opened on a strong note at 71.19 and moved between a high of 70.68 and a low of 71.19 during the day. According to dealers, there was a massive intervention from the Reserve Bank of India (RBI) when the rupee touched 70.65 to protect the exporters.

“Nationalised banks were seen heavily buying dollars to push the dollar-rupee rate up as a result of which the dollar-rupee closed at 70.94, otherwise the rupee could have gone well below 70.50,” said Ashutosh Khajuria, Executive Director at Federal Bank.

On the other hand, the benchmark 10-year bond yield surged 18 basis points and closed at 6.79 per cent on concerns of widening fiscal deficit. The jump in bond yields is the highest one-day surge seen since February 2017. The government estimates the fiscal impact to be about 0 7 per cent of GDP. Bond prices and yields move in opposite direction. A wider fiscal deficit will mean a greater supply of government bonds and the government will need to step up borrowing to fund its fiscal deficit.

“Bond Yields would continue to remain under pressure. Already today there was 25 basis points upward movement in yields from the lowest level of 6.54 per cent of the day,” added Khajuria.

Abheek Barua, Chief Economist at HDFC Bank said, “We estimate that, in the absence of any significant expenditure cuts, the fiscal deficit could rise to 4.1 per cent of GDP in 2019-20. This implies a borrowing overrun of close to Rs 1.5 lakh crore with total borrowing likely to rise to Rs 8.55 lakh crore (from Rs 7.04 lakh crore budgeted) in 2019-20.”

“The 10-year bond yield is expected to trade within a 6.7 to 6.9 per cent range in the near term. We are keeping our dollar/rupee call unchanged at 71-73 in the near term and 69.50-70.50 over the next 3-6 months. While higher equity and FDI flows (driven by today's announcement) are likely to be positive for the currency, concerns over the fiscal situation and risks related to oil could put a floor to the dollar/rupee pair,” added Barua.

The government announced large fiscal stimulus by slashing corporate tax rates for domestic and new manufacturing companies, in a bid to deal with the current economic slowdown and help pump-prime the economy.