Andy Mukherjee: Why India’s budget-makers can’t ignore Japan’s nervous market for government bonds

Volatility spiked last week in Japan’s bond market amid concerns that politicians were losing the plot. Ahead of Japan’s 8 February elections, Prime Minister Sanae Takaichi has promised a two-year cut in the 8% consumption tax on food. The concession could unmoor expectations that government debt will settle at about 222% of GDP by 2030, from about 230% now, the highest among advanced nations.

Looking at numbers alone, India could not be more different. Although its overall GDP will soon be bigger than Japan’s, on a per-capita basis it is 12 times poorer. Public debt has been 80-85% of GDP in recent years. But funding is constrained. If New Delhi doesn’t keep a tight lid on its own obligations, it will be forced to raise funds from a limited pool of creditors at a cost higher than what can stabilize its debt. With 10-year sovereign bond yields inching up to 6.7% and nominal GDP slowing to 8%, the margin of safety demanded by bond investors is narrowing.

So a comparison with the Tokyo tantrum may be useful. From 2025-26, India will adopt public debt as a fiscal target, shifting focus from its annual budget deficit. Japan is headed in the same direction. In theory, the switch gives policymakers more flexibility to counter shocks like the 50% US tariff on Indian exports. New Delhi can, for instance, offer tax breaks to exporters or lower levies on domestic sales. Still, a new fiscal anchor will only be credible if policies remain committed to reducing debt over the medium term.

And there lies the problem. Over the past 12 months, the government has given tax breaks on both income and consumption. Yet the stimulus has done little to shore up nominal GDP. As a result, revenue growth has been weak, which is being compensated by curbing expenditure and pushing some of the spending burden on to states.

While those strategies may be enough to hit this fiscal year’s budget deficit, a new goal post may change the game. Investors will have to be convinced that national income will grow fast enough to curb the Centre’s debt burden to around 50% of GDP by 2030-31 from about 56% now. They would also want to see less profligacy by state-level politicians who have taken to giving free cash to women voters to get re-elected. At 29% of GDP, the states’ combined obligations aren’t much lower than their pandemic-era high.

The domestic bond market is on edge, with yields held in check by the Reserve Bank of India’s liquidity provisions; it has announced a fresh $23.6 billion injection ahead of the budget.

This, too, bears a similarity with Japan, where Kazuo Ueda, the central bank chief, has promised “nimble operations to encourage stable yield formation" if required. But the flip side of RBI stepping in to buy government bonds is that increased money supply could weaken the rupee, adding to cost-of-living pressures like in Japan.

In India, where inflation is currently not a concern, a sliding rupee is spooking foreign investors and tempting the middle class to rotate wealth towards gold from equities and real estate. That doesn’t bode well for economic activity.

Unlike Takaichi, India’s PM Narendra Modi doesn’t have to contend with a general election until 2029. India’s immediate problem is a lack of good jobs and his preferred tool to deal with it is throwing taxpayer money at manufacturers if they start factories in India. However, with China controlling crucial technologies and raw materials just as the US curbs access to its market, India’s room for manoeuvre is limited.

Takaichi’s stimulus seems to have broken her promise of delivering a rare surplus in Japan’s primary budget balance, which measures the gap between revenue and non-interest expenditure.

India also faces a perpetual deficit in its primary balance, which is one of the two crucial variables in debt sustainability calculations. The other is the difference between the economy’s growth rate and the interest on sovereign debt. As a developing economy, India can still deliver double-digit nominal growth to prove to the market that its debt position is sustainable.

The easiest way to do that is to give exporters more free-trade accords, like the recent one with the EU, and release the private sector from stifling bureaucratic controls. Health, education, climate change and income security for the poor need as much emphasis as infrastructure. That will be a more prudent strategy than more big-ticket tax concessions or a splashy increase in spending. ©Bloomberg

The author is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia.