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(Left to right): Mahendra Jajoo, Aditi Nayar, Ajay Manglunia
(Left to right): Mahendra Jajoo, Aditi Nayar, Ajay Manglunia

Impact of rising 10-year bond yields

The yield on 10-year government securities increased around 150 basis points in last few months. We ask the experts about its impact

Given that yield on 10-year government securities increased around 150 basis points in last few months. We ask the experts to share their views on its impact on the economy.

Mahendra Jajoo, head — fixed Income, Mirae Asset Global Investments (India) Pvt. Ltd

Over the last few months, bond yields have risen due to unfavourable macro developments on domestic and global fronts. Domestically, consumer price index (CPI) inflation rose to breach the 5% mark, driven mainly by higher food, fuel and housing prices.... Alongside, post implementation in July 2017, Goods and Services Tax is taking much longer in stabilizing.... This led to lower than estimated revenue, necessitating widening of fiscal deficit to 3.5% of GDP for FY18 as against the original target of 3.2% and higher than budgeted market borrowings. Further, fiscal deficit target for FY19 has been set at 3.3%, higher than FRBM milestone.

With strong economic growth, near full-employment situation and deteriorating inflation outlook, not only is the US Fed set on a gradual rate hike path, it also continues with the pre-announced balance sheet shrinking programme resulting in US10-year-yields inching towards a 4-year high of 3% mark. All these adverse developments, and shrinking surplus liquidity with improved credit pick up, led to a spike in domestic bond yields. Benchmark India 10-year bond yields have risen to as high as 7.75%.

Even as yields have risen sharply, outlook remains clouded. Outlook on monsoon is still unknown and oil prices remain firmly near 3-year highs. In the near term, bond yields may remain under pressure though many now see good value at current elevated levels. Higher bond yields may result in higher cost of capital, resulting in lower profits for corporate sector. Also higher lending rates may slow down housing, auto and other consumer durable demand dampening the recent pickup in growth.

However , a few silver linings have begun to appear, like recent correction in oil prices and strong IIP growth on last two occasions, led by manufacturing growth leading possibly to improved revenue collection. These may help stabilize sentiments in coming weeks and allow bond yields to stabilize near the current levels.

Aditi Nayar, principal economist, ICRA Ltd

Despite an unchanged policy rate, the yield on Government of India (GoI) securities (g-sec) has risen by 150 basis points since September 2017. One basis point is one-hundredth of a percentage point.

This has been driven by various factors, including the rise in the market borrowing programme of the GoI for FY2018 and the slippage relative to the previously announced fiscal deficit targets; the rise in the CPI inflation; the reduction in the systemic liquidity surplus; limited headroom for foreign portfolio investors (FPIs) to invest in Indian g-secs; and hardening global yields. The GoI’s market borrowings net of redemptions are estimated to remain stable at Rs4.6 trillion in FY2019. However, muted demand for g-secs from banks and FPIs, the low likelihood of open market purchases being conducted by the Reserve Bank of India (RBI), and cautiousness about any potential fiscal slippage, may keep g-sec yields at elevated levels. Notwithstanding the inflation risks that it highlighted, the Monetary Policy Committee’s comments on nurturing the economic recovery, and the preference revealed by many members in their minutes to adopt a wait-and-watch policy, suggest a short pause for the policy rate. However, a rate hike may be forthcoming in the second half of 2018, if inflation remains elevated.

Moreover, continued normalisation of the ultra-loose monetary policy, by the central banks of advanced economies, may harden global bond yields in 2018, which would push up domestic yields as well.

Accordingly, Indian bond yields are unlikely to correct meaningfully in 2018, which may shift incremental demand to bank credit from the bond markets. Additionally, the magnitude of issuance from entities rated below the AA category may not immediately see much uptick.

In light of recent developments, if higher risk aversion slows down decision-making in the banking system, the much-awaited investment recovery may get pushed back.

Ajay Manglunia, co — head fixed income advisory, Edelweiss Securities Ltd

Bond yields have gone up by more than 150 basis points since August 2017, and the sell off has gained momentum over the last couple of months.

The initial trigger for the slide was related to:

—concerns over fiscal slippage and incremental government borrowing, and

—concerns over inflation picking up due to rise in crude petroleum and expected higher minimum support price for agriculture.

The appetite and sentiment has only worsened in a web of global and domestic risk factors. The impending concern at the moment is the hawkishness projected by the India’s Monetary Policy Committee as well as the US Federal Open Market Committee (FOMC) at their latest policy review meetings. This has not only driven yields higher but has also resulted in subdued participation from key large investor segments. Despite the hawkishness, a rate hike is not really on the horizon. However, bond yields seem to be pricing in monetary tightening. The spread of the 10-year benchmark over the repo rate is at an unprecedented 175+ basis points and threatens to head higher under the prevalent bearishness.

We believe that the recent sell-off is overdone but sentiment is so beaten down that a strong recovery driven by value buying is unlikely to sustain in the near term. Instead, bonds are likely to meander in a narrow range while tracking the rupee, US treasury yields, and crude prices.

The Monetary Policy Committee is in wait and watch mode as part of its neutral stance and bond markets will also follow a similar approach with an eye on incoming growth and inflation data. In addition to CPI inflation, which has been the most crucial data point thus far, growth numbers will also gain prominence as the Monetary Policy Committee minutes highlight nascent growth recovery as one of the main reasons to retain the neutral policy stance.

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