Pre-budget views

Going into the budget we prefer a neutral strategy, primarily because we are not able to put any informed probability to the outcomes from the budget. The possibility of divergence from expected numbers are too large to merit a trade. We would rather wait for the budget and take a trading call thereon. The reasons for such defensive strategy are:

(i) The Government's strategy seems unclear to us. From announcing corporate tax breaks followed by statements by FM that expenses would not be curtailed, the Government has seemingly backtracked on some of the statements. Thus, what seemed to be an all-out expansionary fiscal policy seems to have turned into a fiscal consolidation - at least as much as reasonably possible. Thus with such apparent paradoxical strategy and statements, it is a roulette call for us to predict the budget theme.

(ii) For FY20, the buyback of 50000 crs that was announced has turned out to be a simple net financing of deficit as no buybacks were done. Thus, what stops the government to announce the buybacks again this year and then later treat it as a financing - thus allowing it to show a lesser financing of fiscal deficit through market borrowing for FY 21.

(iii) The escape clause in the FRBM act allowing RBI to buy directly from Govt in case FRBM limit is breached reduces the hesitancy that Govt may otherwise have to increase the fiscal deficit. The hesitancy is further reduced by the fact that the recent OMO twists by RBI, especially in the liquid 10y segment, have given an impression that RBI wants to control the yields more aggressively and directly and thereby reduced cost of borrowing for the Government.

(iv) The cash accounting basis of the budget has always been a Pandora’s Box, and the issue has only increased lately. Due to the cash accounting nature of the budget, the FY20 extra borrowing numbers should change the FY21 borrowing. Even though this case is true for all the previous years, but with the uncertainty on financing and expenditures for FY20 has put a larger than usual shadow for FY21. However, our view on extra borrowing has changed considerably in the past few weeks and the need for extra borrowing could be less (probably upto 20000crs) - and in case extra borrowing occurs, the same could be offset by year end cash balances or help next year’s deficit.

(v) There’s a possibility of eye-catching announcements like the sovereign bond issuance in last budget. In this budget there is a noise of inclusion in bond indices (or even sovereign bonds). Whilst we believe that there is a real possibility of the announcement of inclusion in indices, but we do not expect the implementation of it to be realistic - especially with India sovereign ratings just a notch above Junk.

(vi) Assumptions in the budget have always been prone to doubts. With the last budgets so off in the assumptions (and only semblance in the fiscal numbers derived from surplus RBI dividend), the risks of budget numbers being difficult to predict have only increased.