Government bond yields surged Monday on account of the government's steep hike of 6.5% in railway freight and volatile crude prices that hit a nine-month high of $115.66 following political tension in Iraq.
The 10-year 8.77% government bonds maturing in 2023 rose 8 basis to 8.80% from Friday's close leading to speculation that inflation, interest rates, currency and current account deficit were under adverse pressure. The rupee, however was steady at 60.21 to the dollar.
"After the sharp rail fare hike announcements last week on passenger as well as freight, the markets perception of the Union Budget slated for July 10 has now changed, for worse," said a treasury head at a foreign-owned bank.
The government last Friday said it would hike passenger railway fare by 14.2% and freight by 6.5% from June 25. The hike will garner about Rs 8,000 crore during the financial year.
According to Shubhada Rao, chief economist at Yes Bank, the immediate impact would be a 10bps spurt in the wholesale price index (WPI) and 6-8% on consumer price index (CPI). The WPI as on May stood at 6.01% and CPI was at 8.2%.
"The perception is of good inflation, as the railway fare hikes have been initiated to augment resources for the government instead of subsidies," Shubhada said.
Bankers said, though interest rates are seen stable, the hikes would have an impact on downstream products like commodities, steel and coal to name a few and as a consequence would be inflationary. Most bankers are keenly monitoring the deficit in the monsoon, seen around 45% this month and the impact on crop prices. All these are leading to a belief that the Budget could be tight and government borrowings would be under control.
"Yields rose on account of three factors, Brent Crude that crossed $115 due to tension in Iraq, ample supply of government bonds and the rail freight hike," said Arun Kaul, CMD at state-owned UCO Bank.
Though WPI would be pressured upward, major worrying fact is the crude oil prices as India was heavily dependent on it for economic growth. "The oil prices would have a major impact on the domestic currency, current account and fiscal deficits," Kaul said.
But the base effect in September will bring down inflation levels, he added.
Though inflation could rise in the short term, Shubdha's view was that the government had enough buffer stock to arrest sharp rises in food grain prices.
The government surplus food stock currently is around 62 million tonnes, much above the desired buffer of 21-23 million tonnes.
While bankers and economists rule out that inflation could lead to higher interest rates but most do agree that the domestic currency, current account and fiscal deficits would come under pressure if global oil prices go above $116 a barrel.