Economy: No borrowing surprise, but risks remain - Kotak

No borrowing surprise, but risks remain. The 2HFY18 gross borrowing comes as budgeted at Rs2.08 tn and is 8.4% lower than last year's. But there seems limited conviction on sustained bond cheer amid fears of (1) possible fiscal slippages, (2) inflation normalization, (3) end of rate-cut cycle, (4) tighter domestic liquidity, (5) reemergence of global reflation theme and (6) possibly tighter global financial conditions ahead. We see benchmark 10-year yield ranging 6.50-6.80% over the next 3-6 months.

Government sticks to the script for now

Belying market fears of fiscal slippages, the government affirmed its FY2018 GFD/GDP target of 3.2%, implying no immediate need for any additional borrowing. However, the government stated that it will assess the fiscal situation and may take a call on additional borrowing after December. The center will borrow Rs2.08 tn on a gross basis in 2HFY18, completing the rest 36% of its gross borrowing program for FY2018BE. This is lower than 39% borrowed in 2HFY17. However, we note that the Rs170 bn G-Sec switch operation to longer tenor securities done in June 2017 involved securities maturing in FY2018. This was technically the government liability for FY2018 and was in fact taken into account while budgeting the gross borrowing amount for FY2018. Thus, ideally the gross borrowing for 2HFY18 should have been at Rs1.91 tn, adjusted for the FY2018 papers switch. The government has also frontloaded 2HFY18 borrowing to 3QFY18. Even as the announced gross borrowing is 8.4% lower than 2HFY17, the 3QFY18 borrowing is still ~2.5% higher than 3QFY18. Net borrowing (excluding buybacks/switch) is placed at Rs1.92 tn. 3QFY18 would also see gross short-term borrowing through T-bills at Rs1.43 tn. Of this, 91-day, 182-day and 364-day paper would respectively account for Rs910 bn, Rs260 bn and Rs260 bn.

Borrowing concentrated in the 10-14 segments; green-shoe option introduced

The weekly dated securities auction size is Rs50-180 bn, unevenly spread over 17 weeks. On the tenor side, borrowings are expectedly concentrated in the 10-14-year bucket (~51% of gross borrowings in 2HFY18). Notably, the RBI/government has now introduced the right to exercise the green-shoe option of up to Rs10 bn in each maturity bucket. However, such green-shoe option will be within the notified amount. This reduces the chances of devolvement in case of lack of demand in any particular security/tenor. Meanwhile, 2HFY18 WMA limits have been kept at Rs250 bn as against Rs600 bn and Rs250 bn in 1HFY18 and 2HFY17 respectively.

The benchmark 10-year yield to hover ~6.50-6.80% over the next 3-6 months

While the market will heave a brief sigh of relief on the back of no additional borrowing announcement, we note that fiscal slippage fears still remain. Amid the current fiscal run-rate and possible revenue losses owing to lower RBI dividend, GST-led possible tax shortfall and weaker disinvestment proceeds, the fiscal slippages could amount to ~0.3-0.7% of GDP (See "Fiscal policy: Between Scylla and Charybdis", September 25, 2017). Other factors that will keep a floor on yields ahead include (1) fears of faster inflation normalization and limited RBI accommodation, (2) possible worsening of bond demand-supply dynamics amid continued OMO sales, (3) tighter domestic liquidity and (4) sluggish FPI flows due to adverse global financial conditions and geopolitical risks. This leads us to believe that the current 10-year benchmark yield may get stuck in the range of 6.50-6.80%, with upward bias (See "India rates: time for reassessment", September 26, 2017). The downside to the range may ensue in the event of (1) no sustained uptrend in global inflation, implying less hawkish DM central banks, (2) RBI cuts amid weaker evolution of growth-inflation dynamics and (3) no additional fiscal borrowings.

Source : Equity Bulls

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