10-year G-Sec yields will average 6.2% by March 2021: Crisil

Credit rating agency Crisil believes that 10-year Government Security (G-Sec) yields will average 6.2 per cent by March 2021 versus its previous estimate of 6.5 per cent.

The agency reasoned that the Reserve Bank of India (RBI) has looked through the current spurt in inflation and stated its commitment to stay accommodative and provide liquidity to the system.

In this regard, Crisil observed that the central bank increased purchase of G-secs by conducting Open Market Operations (OMOs), Operation Twists (OTs), introduction of OMOs for State G-secs, and increase in banks’ limits for statutory liquidity ratio (SLR) securities under held-to-maturity (HTM) to ensure that the demand for G-secs remains strong.

Going forward, the RBI is expected to continue supporting yields, according to a report by a team of Crisil economists, headed by Dharmakirti Joshi, Chief Economist.

OMO purchase is the conventional way by which the RBI buys G-secs in the secondary market.

Under Operation Twists or ‘special OMOs’, the RBI simultaneously buys long-term and sell short-term G-secs. This reduces long-term yields and raises short-term yields, thereby flattening the yield curve and reducing term premium, without adding to systemic liquidity.

“Though fundamental pressures from a large borrowing programme have accentuated, we believe that 10-year G-sec yields will average 6.2 per cent by March 2021 versus our previous estimate of 6.5 per cent,” the agency said.

The last traded yield on the benchmark 10-year G-Sec (coupon rate: 5.77 per cent) on Monday was around 5.89 per cent, with its price at ₹99.10. Bond yields and prices move in opposite directions.

Upside risks to yields

Simultaneously, Crisil cautioned that upside risks will yields persist.

This can materialisein case of higher fiscal slippage leading to further increase in market borrowing; possible drying up of bank appetite for G-secs once domestic demand improves and credit offtake picks up; and sustained inflationary pressures amid improving demand, which will constrain the RBI’s ability to maintain surplus liquidity.

The agency observed that while RBI is using a wider range of tools to ease yields, the easing itself could face limits from other factors. Specifically, its willingness to conduct OMOs will depend on to how much surplus systemic liquidity it is comfortable with.

When the RBI conducts outright open market purchases of G-secs, it adds to systemic liquidity.

“Liquidity has already been in surplus with domestic credit not picking up. This has further been boosted by surging foreign capital inflows amid global monetary easing.

“Given that the current account balance is also in surplus, the RBI’s attempts to control excessive appreciation of the rupee have further added to domestic liquidity,” the report said.

Foreign inflows impact bond yields

The agency assessed that only 41 per cent of the debt limit was utilised by foreign portfolio investors (FPIs) until October, down from 75 per cent in January 2020. Post that, the Covid-19 pandemic and fiscal stress seem to have kept foreign bond investors at bay, despite easy global conditions.

Crisil opined that growing fiscal stress in India could continue to dissuade FPIs from the G-sec market. India’s growth-inflation mix has also fared worse than its peers, it added.