Finance Sector and Budget: A season of stark contrasts for banks and corporate bonds

The Interim Union Budget for 2024-25 continued to tread the path of fiscal consolidation, in the backdrop of a healthy domestic economic environment. It pegged the Government of India’s (GoI) fiscal deficit at 5.1 percent of GDP for the next fiscal, midway through the revised estimate of 5.8 percent for FY2024 and the medium-term fiscal deficit target of 4.5 percent for FY2026. Accordingly, the gross and net market borrowings for GoI for FY2025 have been curtailed to Rs 14.13 lakh crore and Rs 11.75 lakh crore, respectively, from the Rs 15.43 lakh crore and Rs 11.80 Lakh crore, respectively, estimated for FY2024.

Lower borrowing costs for corporates and treasury gains for banks: The yield on 10-year benchmark GoI security had already opened lower by 2bps at 7.12 percent after the positive commentary by US Federal Reserve about the inflation trajectory. It gained further momentum after the lower-than-expected fiscal deficit numbers for FY2024 and FY2025. The yield on benchmark security rallied to 7.05 percent after the budget announcement before a partial reversal. The decline in risk-free benchmark will provide shore up treasury profits for banks. A decline in the risk-free rate will also drive lower yields on the corporate bonds, making it cheaper for large well-rated corporations to borrow funds from the debt capital market.

Challenges in passing on rising cost of deposit for banks: These developments may however mean that the ability of the banks to pass-on the rising cost of deposits by way of hiking lending rates may get constrained. Given the tight liquidity in the banking system, which is likely to continue for a few months, there will be a sustained pressure on the deposit costs of the banks, and this could mean higher pressure on their interest margins, especially while lending to larger corporations. A meaningful shift to the debt capital market by larger corporations could also mean slower credit growth, which coupled with pressure on interest margin may constrain the earnings growth momentum of banks seen in the recent past.

Corporate bond issuances to improve: While we expect the corporate bond yields to decline, which may benefit the larger well-rated corporations that can borrow meaningfully from debt capital markets, tighter liquidity situations may result in some widening of the spreads for corporate bonds over the risk-free rate. Nonetheless, higher credit spreads and lower market borrowings of GoI shall improve the investor’s appetite for corporate bonds, which shall augur well growth of debt capital markets. Non-bank finance companies (NBFCs), which are facing some funding challenges after the increase in risk weight on bank lending to NBFCs are already the biggest borrowers in the debt capital market. The evolving dynamics between bank funding and debt capital market funding cost, shall further incentivise the NBFCs to increase their share borrowings from capital markets to fund their growth.