Indian government bonds experienced a decline on Tuesday following Bloomberg Index Services' decision to defer the inclusion of Indian debt in its flagship Global Aggregate Index. The move surprised traders who had already factored the expected inclusion into bond prices.

Bond Yield Movement

The benchmark 10-year government bond yield demonstrated the market's disappointment with the deferral decision:

Bond yields move inversely to prices, indicating that bond values fell as yields increased.

Bloomberg's Decision Rationale

Bloomberg Index Services explained that the deferral stems from operational and market-infrastructure considerations that require additional evaluation. The index provider noted that several respondents highlighted important factors that merit further review before proceeding with inclusion. The review for inclusion remains open and ongoing, according to Bloomberg.

Market Impact and Expectations

The decision significantly impacted market sentiment, as investors had largely considered the inclusion a certainty. Market expectations had been substantial:

"The decision disappointed markets that had largely priced in inclusion this month, with expectations of up to $25 billion in inflows over 10 months," said Harsimran Sahni, head of treasury at Anand Rathi Global Finance. Sahni noted that the deferral comes as a surprise given that Indian bonds have steadily gained entry in major emerging market benchmarks.

State Bond Auction Performance

Despite the disappointment from the Bloomberg decision, the rise in yields was somewhat limited due to marginally better-than-expected demand from long-term investors. The state bond auction saw participation for bonds worth ₹268.15 crores.

Overnight Index Swap Rates

The bond market decline also affected India's overnight index swap rates, which moved higher across the curve:

The longer end of the swap curve led the upward movement, tracking the rise in bond yields. Market focus remains on geopolitical risks and higher oil prices due to potential supply disruptions.

India's central government is well-positioned to achieve its fiscal deficit target of 4.4% of GDP for FY26 despite facing revenue challenges, according to recent analysis from ANZ Research. The assessment comes as the government prepares for the upcoming Budget session amid evolving fiscal dynamics.

FY26 Fiscal Deficit Outlook

Dhiraj Nim, Economist and FX Strategist at ANZ Research, expressed confidence in the government's ability to meet its fiscal consolidation goals. In an exclusive interview with NDTV Profit on January 13, he outlined the key factors supporting this projection.

"A mildly lower fiscal deficit ratio can deliver the desired debt-to-GDP ratio. The key expectation from the upcoming Budget session is that the government would be able to meet fiscal deficit target of 4.4% of GDP for FY26," Nim stated.

The analysis indicates that strong real GDP growth will provide a favorable backdrop for fiscal management, allowing the government to maintain its consolidation path without aggressive spending cuts.

Revenue Challenges and Mitigation Strategies

Despite the positive outlook, the government faces significant revenue headwinds. Nim expects a substantial net tax shortfall due to an unexpected decline in tax buoyancy throughout the year.

"Thanks to the large central bank dividend and some expenditure rationalisation both on account of capex and non interest revenue expenditure, the government would be able to just meet its fiscal deficit target," Nim explained. This approach will be implemented without disrupting the broader borrowing program.

Non-tax revenues are expected to provide additional support, with projections suggesting they could exceed budget estimates by 0.20% of GDP. Excess central bank dividends will remain a crucial revenue source, while weak oil prices are anticipated to generate higher dividends from oil marketing companies.

FY27 Fiscal Consolidation Framework

Looking ahead to FY27, the fiscal landscape presents tighter constraints. Nim emphasizes the importance of conservative tax assumptions in budget planning for the coming fiscal year.

The FY27 fiscal deficit target represents an 'endogenous' target as the government transitions from traditional fiscal deficit targeting to a debt targeting framework. Under this new approach, the government may target debt at 55% of GDP.

"Even if the RBI dividends remain quite large, the government will have to reduce its expenditure by 20 bps of GDP to meet its fiscal deficit target which we expect to be 4.2% of GDP," the economist noted.

Strategic Fiscal Transition

The analysis suggests that India's fiscal consolidation strategy reflects a measured approach to debt management. The economic outlook for FY27 and the debt targeting methodology indicate that aggressive fiscal tightening may not be necessary to achieve desired debt sustainability metrics.

The transition to debt targeting represents a significant shift in fiscal policy framework, potentially providing greater flexibility in managing short-term fiscal variations while maintaining long-term debt sustainability objectives.

Source: https://www.ndtvprofit.com/budget/budget-2026-will-govt-meet-fy26-fiscal-deficit-target-economist-eyes-firm-capex-despite-tightness