05 Feb Higher Fiscal Deficit & Debt Funds
The Case of Higher Fiscal Deficit and Debt Funds
1) India’s fiscal deficit is expected to be around 9.5 per cent of the GDP for the current fiscal owing to less revenue collection due to the COVID-19 crisis,
2) This would be a 300 per cent higher than what was planned earlier which was 3.5 per cent of GDP pegged for the current fiscal.
3) This means if government plans to spend Rs 100 & earn Rs 90.5
4) It is ok to spend more than you earn if your spends are directed towards building productive assets like infrastructure which will eventually increase productivity of the economy
5) This is like investing in yourself by spending money on your training because once you are trained you will earn a higher income
6) But the question to ask is “How will the government get the additional money which it does not earn?”
7) It will come through increase in government borrowing from the RBI
8) RBI may print more money to be able to lend more to the government
9) When there is more demand for money, the cost of borrowing shoots up. This will increase Interest rates because interest rate is same as “cost of borrowing”
10) When more money is printed without proportiate increase in goods and services, the value of money comes down. This also means you will need more money to borrow money from banks which is nothing but higher interest rates
11) When Interest rates go up, all previously held long duration debt papers will lose value and funds like Income Fund, GILT fund, Banking and PSU Bond Funds and Corporate Bond Funds are likely to see NAV coming down (how this happens will be explained in another article as it is beyond the scope of this article)
12) Hence it would be prudent to move into funds having low duration debt papers. Low duration funds is better because once the previous low duration papers carrying lower yields mature, the fund will buy new papers with higher yields.
(This service is supported by UTI Mutual Fund & Mahindra Mutual Fund)