GST Reform Impact: Equity Markets Cheer, Bond Markets Tumble On Fiscal Concerns, Likely Rate Cut Delay

In his Independence Day address, Prime Minister Narendra Modi had announced the government would rationalise Goods and Services Tax rates to ease the the indirect tax burden. While equity markets cheered the move, debt market participants grew wary, citing concerns over a possible delay in rate cuts and rising fiscal risks.

On Aug 18, in the trade session post-GST reforms announcement, the NSE Nifty 50 jumped 1.59% to 25,022 during the session. It ended 1% higher at 24,876.95.

Last week, the index clocked its best winning streak since April, driven by optimism about an uptick in consumption.

External volatility which weighed on India Inc.'s earnings growth has posed a key challenge to sustaining consumption. Though rural demand helped, urban demand emerged as the biggest draw.

Indirect tax reforms, once implemented, are expected to boost urban consumption, according to market experts. Emerging markets, particularly India, are poised for strong performance amid monetary and fiscal changes, said Nilesh Shah, founder of investment management institution Envision Capital last week.

Before this policy support, the Reserve Bank of India delivered a jumbo rate cut of 50 basis points and CRR cut to infuse liquidity into the system to support demand.

Meanwhile, bond yields have spiked since the announcement of GST reforms as market participants weighed the probability of diminishing chance of rate cut and fiscal concern.

Sharp decline on bond yields on Aug. 14 on the back of sovereign rating upgrade reversed quickly. The yield on India's benchmark 10-year bond rose to 6.56% on Friday, the highest level since March 28, according to Bloomberg data.

Bond prices and yields share an inverse relationship.

The spread between the 10-year yield and RBI's policy rate increased to a two-year high last week. Traders are expecting the trend to continue, Bloomberg reported.

Nomura estimates the move may reduce tax collections by Rs 1.5 lakh crore, equivalent to 0.45% of GDP. Investors are concerned about the Central or state governments tapping debt markets to manage the impact of revenue loss stemming from GST reforms.

IDFC First Bank noted that the rate cut from the RBI could be postponed to December, but retained their forecast of a rate cut in October as of now, said Chief Economist Gaura Sengupta.

"It (rising yields) will come under control once the fiscal hit is priced in. And once markets start to expect a rate cut that will be another support," Sengupta said.

IDFC First Bank is expecting the yield on the 10-year bond to trade between 6.35% and 6.65% in near term as it prices in the fiscal impact.