Government said its fiscal deficit would be 3.3% in 2018-19, higher than market expectations of 3.2%.
Mumbai: Indian bonds slumped on Thursday after the government set a slightly wider-than-expected budget deficit target for the next fiscal year, while shares clawed back earlier losses as investors welcomed spending in key areas of the slowing economy.
Finance Minister Arun Jaitley set the government's fiscal deficit at 3.3 percent of gross domestic product for the 2018/19 fiscal year, higher than market expectations of 3.2 percent.
But analysts said the falls in bonds may not be sustained in the near-term given the widening in the deficit was not as large as some investors had feared. It's the last full-year budget from Prime Minister Narendra Modi's government before a national election due by May 2019.
Shares initially sold off after Jaitley announced a new capital gains tax on long-term equity investments. However, they later recovered as investors welcomed a budget that allocated billions of dollars to the rural sector and lowered corporate taxes.
"The government should be commended for sticking to fiscal discipline. While a small amount of slippage did occur, the larger point is that populist measures have been avoided, and all initiatives are centred around development, growth," said Sunil Sharma, Chief Investment Officer at Sanctum Wealth Management.
The yield for the benchmark 10-year bond rose as much as 17 basis points to 7.60 percent from the previous close.
The Nifty fell as much as 1.3 percent after Jaitley announced the long-term capital gains tax, but was flat as of 0956 GMT.
India currently does not tax capital gains on equities if the investments were held for more than a year earlier before selling.
The rupee weakened to 63.7450 per dollar from its 63.58 close on Wednesday.
India's economic growth had been hampered by a chaotic rollout of a goods and service tax last year and a shock move to ban high value currency notes in late 2016, creating complications for the government in its efforts to craft a balance budget.
India was expected to loosen its fiscal deficit targets, which were previously set at 3.0 percent of GDP for 2018/19, however, investors had said they would be willing to accept a modest widening in the budget shortfall as long spending was targeted to key sectors.
India's economy is expected to grow 6.75 percent in the year to March, but is projected to pick up to 7.0 to 7.5 percent in the next fiscal year, once again becoming the world's fastest-growing economy..
Nonetheless challenges remain to the outlook for markets, as a spike in inflation has hit bondmarkets, with the 10-year bond yield having risen more than 80 basis points since July - the biggest spike since the 2013 rupee crisis.
Stocks have been more resilient, gaining 4.7 percent this year and hitting records amid signs earnings are recovering after years of poor performance.