The markets were expecting something big in FM's budget speech but all those expectations turned into disappointments as there was nothing according to expectations. Both bond and equity market went into distracted state as FM announced that the fiscal deficit would be 6.8% of GDP. And then as a result the benchmark index closed as 6% down on that day while on other hand 10-yr govt. paper yield was shot up by approx 1.3% which means that bond price and bond yield moves in opposite direction.
Lets try to understand that why there was such type of response in both the markets due to this economical number.
In a very simple way the fiscal deficit can be understand as the amount by which the govt. expenditure exceeds its receipts including borrowings. So now its clear that if this fiscal deficit moves up then govt. will have to borrow more funds in order to its expenditure. In the current financial year our fiscal deficit figure is about to 4 lakh cr. which is approx four times more than the budget estimates in last yr.
If govt. will borrow approx 4 lakh cr from market then its clearly means that there will be less fund available with banks for public sector. Our privet investment will suffer ans so will our growth. If the system is left with fewer rupees to lend, there will be a demand-supply mismatch and interest rates will move up.
This is the reason that interest rate sensitive stocks lost their value in the market on the budget day. When interest rates move up, bond prices fall as investors chase bonds offering higher rates. As its widely known that banks hold a substantial part of their portfolio in bonds. Thus, falling bond prices affect their profitability. BSE Bankex sold the most on the day the Budget was announced.
The story doesn't stops here only. Higher fiscal deficit over a period of time brings instability into the financial system. As a result, there is a fair chance of India getting downgraded by international credit rating agencies. This will make India more risky for foreign investors and lenders. Consequently, lenders would charge a higher rate of interest on borrowings from Indian companies.
The other most important impact of higher fiscal deficit is this that it will affect the exchange rate. So as a result our import will move on and increase in import will increase demand of foreign currency. This increased demand of foreign currency will affect the value of Indian Rupee and as a result our currency (INR) will depreciate.
Lets try to understand that why there was such type of response in both the markets due to this economical number.
In a very simple way the fiscal deficit can be understand as the amount by which the govt. expenditure exceeds its receipts including borrowings. So now its clear that if this fiscal deficit moves up then govt. will have to borrow more funds in order to its expenditure. In the current financial year our fiscal deficit figure is about to 4 lakh cr. which is approx four times more than the budget estimates in last yr.
If govt. will borrow approx 4 lakh cr from market then its clearly means that there will be less fund available with banks for public sector. Our privet investment will suffer ans so will our growth. If the system is left with fewer rupees to lend, there will be a demand-supply mismatch and interest rates will move up.
This is the reason that interest rate sensitive stocks lost their value in the market on the budget day. When interest rates move up, bond prices fall as investors chase bonds offering higher rates. As its widely known that banks hold a substantial part of their portfolio in bonds. Thus, falling bond prices affect their profitability. BSE Bankex sold the most on the day the Budget was announced.
The story doesn't stops here only. Higher fiscal deficit over a period of time brings instability into the financial system. As a result, there is a fair chance of India getting downgraded by international credit rating agencies. This will make India more risky for foreign investors and lenders. Consequently, lenders would charge a higher rate of interest on borrowings from Indian companies.
The other most important impact of higher fiscal deficit is this that it will affect the exchange rate. So as a result our import will move on and increase in import will increase demand of foreign currency. This increased demand of foreign currency will affect the value of Indian Rupee and as a result our currency (INR) will depreciate.
Dear I didn't understand last para, as you quoted there that increased deficit will surge demand for foreign currency, which in my view will result in lower demand for Rs. and thus lowering the value of our currency which indeed increase the competitiveness of our exporters and will increase our exports.
ReplyDeleteapart from this we are this we are going through some reforms and we will surely see that much bigger pie government ownership will be sold in market, so no need to be disappointed. We have seen positive move in equity which is the most leading indicator available, but bond market is still cautious inanticipation of huge supply of bonds from government.
Sandeep Varma
(9930280397)