The recent hardening of yields on government securities (Gsecs) poses a fresh set of challenges to the Centre. 10-year government bond yield surged to 6.636 per cent on Monday, reflecting the nervousness in bond markets. The Reserve Bank of India has once again begun its battle at government bond auctions to keep yields low. But the experience of the central bank over the last two years shows that it is not possible to rein in bond yields for long. There are multiple challenges facing bond market participants at the current juncture. Consumer inflation moved to a 25-year high in the US and hit record levels in India and other countries, led by energy and food prices. The spike in inflation has made global bond yields move sharply higher, causing reallocation of foreign portfolio money to safer havens such as US treasury securities.

The other factor applying pressure on bond yields is the revision in global central bank policies towards accelerated monetary tightening. Indian benchmark G-sec yields have hardened almost 50 basis points since September 2021, when it became clear that the Federal Reserve is likely to begin aggressive rate hikes in 2022. The December Federal Open Markets Committee meeting reinforced these fears with the Fed indicating three rate hikes in its funds rate along with shrinking of its balance sheet in 2022. This has led to immense turbulence in global bond markets with yields in European countries rising between 25 and 40 basis points over the past month and 32 bps in the US. The increase in G-sec yields in India cannot be brushed aside lightly since they have a strong influence on other interest rates in the economy. For instance, AAA-rated corporate bond yields had surged past 7 per cent, AA-rated bond index moved close to 8 per cent and BBB-rated bond yields hit 11 per cent mark in January. At a time when the economy is grappling with the consequences of the movement restrictions due to the Omicron variant of Covid-19, rising interest rates can deal a fresh setback to businesses. Rising bond yields have also increased the Centre’s cost of borrowing. Interest payments of the Centre are 20 per cent higher in the April to November 2021 period when compared to the same period a year ago. While this is partly due to additional borrowing this year, the gradual hardening of yield is also playing a part.

The Centre was right in giving precedence to reviving growth and supporting the economy in the Union Budget of 2021, despite the resultant expansion in fiscal deficit and government borrowing. But Finance Minister Nirmala Sitharaman will have to begin the move towards greater fiscal prudence in the upcoming Budget, for the large government borrowing is beginning to affect interest rates in the economy and is threatening the nebulous recovery. While a reduction in capital expenditure is not recommended, tighter control on revenue expenses may be needed in the upcoming Budget to show a lower deficit number and rein in bond yields.

comment COMMENT NOW