The bond markets, which were fearing the worst last week, were pleasantly surprised with the Budget 2016-17. By adhering to the fiscal deficit of 3.9 per cent for FY16 and targeting 3.5 per cent for FY17 and 3 per cent for FY18, the government has reinforced its commitment to FRBM and maintained its “prudent fiscal management” credibility. It has shown restraint in any manner of fiscal stimulus, which is appropriate for an economy with an expected growth of 7.5 per cent and a likely inflation of 5 per cent. The markets rallied sharply by over 15bps in the day and by over 25 bps over last two days. There is an expectation of a 25-50 bps of rate cut from the RBI as one of its critical requirements has now been met.
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By creating a conducive environment for further easing by RBI, it helps corporates lower the cost of capital and also provides investors with an opportunity to gain from investments in debt funds as yields fall in the short term. Going forward, the debt markets are expected to be volatile as the focus shifts back to global growth, forex reserves, portfolio flows and appetite for emerging market debt. The deterioration in credit profile of some of the large borrowers and the pressure on banks asset quality will pose a challenge for the mutual fund industry.
In our view, investors will gain from an overall asset allocation in favour of debt this year. They should stay invested in long-term or dynamic bond funds but increase allocation to the short-term funds in their fixed income portfolios.
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