The RBI’s battle of nerves with the bond market on where the government bond yields should trade, while being quite entertaining, seems futile. The odds are stacked high against the central bank — a gigantic government borrowing schedule, prospects of a faster economic recovery due to the Covid-19 vaccine rollout, and inflation beginning to rise again.
It is fairly obvious that the central bank’s stance on keeping the yield of the 10-year bonds close to the pre-Covid levels is driven by the need to control the borrowing cost of the Centre. The weighted average yields of new government bond issuances have averaged around 5.82 per cent in the first half of FY21 and the Centre seems to want pricing to remain close to these levels.
But the attempt to force the 10-year bond yield lower — with consequent bond auctions devolving on primary dealers — is getting quite farcical. It needs to be noted that India is not the only country where bond yields have hardened in February. The yield curve has become steeper in most countries due to the optimism fuelled by the Covid-19 vaccine rollout.
As growth improves, Indian G-Sec yields are going to rise further. And that is not such a bad thing, as it is good for savers. Also, empirical data shows that economic growth has been strong in periods of rising yields and vice versa. The RBI can, therefore, restrict itself to infusing confidence in the market about its ability to manage the government borrowing in the least disruptive manner.
Steeper yield curve
One of the reasons why there was a sharp sell-off in global equity market and in alternative assets such as Bitcoin over the last couple of weeks was due to the spike in global bond yields. The US 10-year government bond has moved up from 0.93 per cent towards the beginning of 2021 to 1.37 per cent now; back to pre-Covid level. The yield curve of countries including the US, Germany, Australia and Canada have shifted higher over the past month as hopes of economic stability improved.
But while global yields have hardened, they still remain at historic lows. For instance, the US 10-year bond yield is much lower compared with the November 2018 level of 3.2 per cent or the pre-global financial crisis level of 5 per cent.
Indian yields are also showing similar traits. The entire government bond yield curve has shifted higher in February compared to one-month before. While the RBI has been intent on keeping the 10-year bond yields under control (the 10-year bond yield has increased 5 per cent year-to-date), there is a much steeper increase in other tenures.
For instance, the 3-year bond yield was 4.374 per cent on January 4, but had hardened to 5.024 per cent by February 22, increasing 15 per cent. Similarly the 1-year bond yield is up 12 per cent in the same period. Of note is the dip in India’s yield curve in the 10-year bonds. The RBI’s interference at this tenure is resulting in an inversion of sorts, with the 6, 7, 8 and 9-year bond yields higher than the 10-year bonds.
Why RBI can let go
If we look at the long-term chart of the India’s 10-year bond yields, it is seen that the bonds are currently trading close to their historic lows. The lowest point in the last 25 years was recorded in 2003 and again in 2008 when yields were around 5 per cent. The recent low of 5.8 is the third lowest point in this period and the current yield is just 6 per cent above. But the upper end of the range since 2001 is quite high, at 9 per cent.
It is also seen that increase in bond yields has often accompanied good economic growth. For instance in the period between 2003 and 2008, yields increased from 5 per cent to 9.32 per cent. But this was the period of economic boom for the country with GDP growth ranging between 7.8 to 9.8 per cent. Similarly, the period between 2009 and 2011 too saw double-digit growth along with sharp increase in yields. On the other hand, periods of falling bond yield, as seen between 2000 and 2003 have been accompanied by falling growth.
These numbers show that the RBI need not worry about higher bond yields increasing borrowing costs in the economy and derailing growth. While phases of higher growth have been accompanied by higher inflation and increase in policy rates, higher demand have offset the negative impact of higher interest rates.
At current juncture, credit growth is still very weak and there is ample liquidity in the system. So there is no immediate danger of the private sector getting hit by higher borrowing cost due to rising yields.
Centre can bear higher interest
The dogged effort to keep the 10-year rates lower is clearly an effort to help the government borrowings. Of the primary issuances of government dated paper between FY17 and Q2 of FY21, 36.2 per cent of the securities were issued in the 10 to 14 year bucket. The next preferred bucket was 5-9 years, with 21 per cent of the issuances.
The weighted average yield of new issuances have been coming down over the years, from 8.51 per cent in FY15 to 5.82 per cent in H1 of FY21. It’s therefore not surprising that the RBI has been mandated to manage the borrowing around 5.82 per cent. But a back-of-the-envelope calculation shows that 50 bps increase in interest cost will increase interest on fresh borrowing next fiscal year by ₹6,400 crore only.
With the Centre already having bitten the bullet in bringing many off-balance sheet items on the books and showing a higher deficit, it should not balk at a slightly higher interest outgo, which is a natural outcome of higher borrowing.