InvestorQ : What will be the impact for the Indian economy if the fiscal deficit is allowed to cross 4% mark and do you see an equity sell-off?
Rashi Mehra made post

What will be the impact for the Indian economy if the fiscal deficit is allowed to cross 4% mark and do you see an equity sell-off?

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sarah Leo answered.
1 year ago
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That will not be good news and it will be best to keep the fiscal deficit under the 3.8% mark; in fact the lower the better. There are two important implications of a higher fiscal deficit that has to be kept in mind.

Firstly, you must beware the rating impact. Major chunk of the FPI flows post 2005 were in the light of the greater sense of fiscal responsibility shown by successive governments. Even at the height of the global crisis in early 2016 when global markets had lost $12 trillion in market value, the 2016 Union Budget stuck to its fiscal discipline. That was one of the key reasons that spurred the Nifty to virtually double from these levels over the last four years. Neither the global rating agencies, nor global portfolio investors are likely to take very kindly to a sharp spike in fiscal deficit. The onus will be on the finance minister to underline that fiscal deficit spillage is temporary and should revert back to normal levels in a time bound manner.

More than the rating, the bigger challenge will be the hardening of bond yields. The broader concern on the fiscal deficit front is the impact that it will eventually have on the bond yields. Higher fiscal deficit is a signal of a government hungry for borrowings and that could crowd out private sector. As the state borrowings increase, the immediate impact will be a spike in yield due to an increase in credit demand. The 10-year bond yield benchmark is the most risk-free instrument. That will mean; any spike in yields could directly impact the cost of funds for corporates. Higher bond yields could negatively impact bond and equity prices and that could be the real issue to be cautious about.

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