Copyright thehindubusinessline
The relative stickiness of the 10-year bond yield has been an enigma. When the monetary policy was announced in June it was largely expected that the 10-year bond yield, which was at around 6.20 per cent, would move closer to the 6 per cent mark. However, it climbed upwards towards the 6.50 per cent mark and remained in this region while briefly crossing the 6.60 per cent threshold. Just what is happening in this market? The reasons for expecting the bond yield to come down are rather clear. First, the RBI has lowered the repo rate by 100 basis points (bps) this year which should ideally have brought this yield down proportionately. Second, banks have lowered their lending rates by a little over 50 bps, going by the weighted average lending rate. The deposit rates denoted by the weighted average term deposit rate are down by over 100 bps. Banks are also one of the largest sets of players in the G-Secs market. Yet, they do not seem to have impacted the bond market. The RBI has also lowered the CRR by 100 bps releasing around ₹2.5 lakh crore which is in the process of being implemented, with 50 bps’ funds equivalent having been released. The market, however, has a different view. It was not enthused by the June policy, which in turn indicated that there would be no further rate cuts given the limitation of rates in influencing growth. The stance was also changed to neutral. A neutral stance is taken to mean that a rate cut could not come without this being changed to ‘accommodative’. It is another matter that a rate cut has been carried out in the past without a change in stance. Second, the announcement of GST cut was taken to be very good for the economy. However, any GST cut involving a dip in revenue for the government also implies that the fiscal deficit can rise, leading to higher borrowings. In fact, this apprehension probably explains why the yields crossed 6.60 per cent briefly. Interestingly there have been two announcements in the last couple of months, which should have moved the needle. The first is the articulation in the October policy that there was scope for measures to support growth if needed. Second, the government borrowing calendar was announced which does not involve any excess borrowing — meaning that there will be no pressure on liquidity due to the GST cuts. Yet, the yields have remained inflexible. Plausible explanations There are some plausible explanations here. The first is in the banking area where growth in credit has picked up, especially in the last fortnight ending October 3. This trend will persist since the boost provided to the consumer goods industry through the GST will revive the investment spirit. Therefore, growth in credit to the non-retail non-agriculture sector will witness acceleration. The swings in surplus liquidity witnessed in recent times bear testimony to this sentiment. Deposit growth will always be a challenge given that the stock market and mutual funds offer higher returns. Another factor has been the forex market. The rupee has been volatile with the value going closer to the ₹89/$ mark before moderating to levels of under ₹88/$ presently. The conundrum in this market for the central bank is that when the rupee falls, the market expects some view from the RBI. The RBI maintains that it has no view but is against too much volatility. Hence if the rupee declines and there is no talk or action, a self-fulfilling cycle builds up. Exporters expect further depreciation and hold back earnings. Importers buy more dollars in the market to eschew paying higher price for the dollar in future. This exacerbates the demand-supply situation leading to further depreciation. There have also been some developments in the forex market. The foreign currency assets have declined almost $15 billion from $587 billion on September 12 to $572 billion on October 10. This could be on account of a combination of two factors. There would be direct sales of dollars in the market to support the rupee or control volatility. The other is the sorting out of the forward book. There were short positions of $14.4 billion for September-November which would mean absorption of rupees if not rolled over, hence affecting liquidity. At a broad level this would negate the 50 bps cut in CRR witnessed in the last two months. Therefore, there are various forces at work explaining the stickiness in bond yields. Effect on other markets This affects other markets too. The 10-year yield is for all purposes the benchmark and gets linked to other securities dealt with in the market. This pushes up yields in the corporate bond market as well as those on SDLs (State development loans). The latter have been affected even more by virtue of the concerns on the collective deficits of States. The spread of SDL over G-Sec was 30-35 bps in June, which has risen to 70-75 bps. This will have a bearing on State finances as their interest costs increase, and when combined with potential lower collections on GST in the short run can indicate higher borrowings or trimming of discretionary expenditure like capex to balance budgets. The corporate bond market has done better. The spread of 70-80 bps for AAA companies has been maintained though the absolute rate has gone up. This will slow down the pace of bond issuances depending on the relative levels of the MCLRs that they would contend with in the banking system. However, once the rating slips downwards to say AA, the spread is as high as 300 bps but has not quite changed since June. Can anything be done to lower these yields? The answer is probably not much, and the market will decide. Announcing open-market operations and supplying a large quantum of funds can help. But managing bond yields and currency simultaneously can mean moving around in circles, which is probably not desirable. The writer is Chief Economist, Bank of Baroda. Views are personal Published on October 27, 2025
