By Archana Narayanan and Aditya Phatak
MUMBAI (Reuters) - The budget for the next fiscal year sorely disappointed investors with a higher-than-expected market borrowing programme sending long-end swap rates to near 8-month high, and the benchmark bond yield to its highest in two-and-a-half months.
Finance Minister Pranab Mukherjee said the government was targeting 5.7 trillion rupees in borrowing in fiscal year 2012/13, higher than the expected 5.3 trillion, raising doubts over the government's ability to keep its finances under control.
The government did try to tighten its belt by projecting a decline in the fiscal deficit to 5.1 percent of gross domestic product in 2012/13 starting in April from 5.9 percent in the current year, but even that was seen by some analysts on the higher side.
The low confidence in India's ability to keep its deficits under control -- spending was set to rise 29 percent in the next fiscal year -- is raising more doubts about the timing and scope of interest rate cuts in an economy that is clearly showing signs of slowing.
The budget added to the perception the Reserve Bank of India would be forced to either delay or reduce the magnitude of cuts in the repo rate, a day after it cited inflationary pressures from government finances a key reason behind its decision to keep rates on hold.
"The budget is negative for the INR, because high twin deficits and high inflation may discourage some foreign investors," said Dariusz Kowalczyk, senior economist and strategist at Credit Agricole in Hong Kong.
"It is also negative for government bonds. RBI has a bit less rate cut room now, although we still expect a cut in April."
The reaction in stock investors was also of disappointment, sending India's main index down more than 1 percent each, in the absence of more reforms to help a corporate sector facing a slowing economy and the central bank reluctant to step in by cutting rates.
In debt markets, the 10-year benchmark bond yield was at 8.43 percent, after touching 8.44 percent, a level last seen on January 2, and up 10 basis points from before the borrowing data in the budget was released.
The benchmark five-year swap rate rose 6 bps to 7.61 percent, its highest since July 29 2011, according to Thomson Reuters data. The one-year swap rate rose 7 bps to 8.22 percent.
The Indian rupee initially fell tracking shares, but recovered all its losses as some local gold importers unwound long-dollar positions after the government's proposed doubling of import duties on gold was seen hitting demand.
The currency was last around 50.30/31 to the dollar after dipping to 50.4350, but stronger than Thursday's close of 50.38/39.
In the scope of a week, the Indian markets have done an about-face. The RBI cheered investors by delivering a surprise cut in the cash reserve ratio last Friday, setting up expectations it would follow up with a cut in the repo rate.
But the central bank's surprisingly hawkish statement on inflation on Thursday reduced expectations of how soon it can reverse 13 consecutive tightening moves.
"The fiscal situation will adversely impact the monetary policy," said Rupa Rege Nitsure, chief economist of Bank of Baroda in Mumbai.
"I think the RBI may announce a token 25 basis points of rate cuts in April just to boost confidence, but I am not sure."
(Reporting by Aditya Phatak and Archana Narayanan; Writing by Rafael Nam; Editing by Rajesh Pandathil)