Bond market turbulence

Bond market turbulence

The Indian bond market is exhibiting turbulence again. Yields on the 10-year bond are on a 17-month high. Concerns over inflation and the Union government’s record level borrowing have spooked the market. Yield on the benchmark 10-year bond hovered around 8% on Tuesday.

In bond markets, interest due on bonds (called the yield) and their price are inversely related. A higher yield implies a lower bond price. The current fall in the market is largely due to a combination of worries over inflation and the government’s borrowing programme (that begins in April). These worries are also reflected in the five-year interest rate swap, an instrument used for protection against volatility in borrowing costs, which has risen in recent days.

The Union government’s opacity on how it will manage its gigantic borrowing of Rs4.57 trillion in 2010-11, its inability to meet revenue deficit targets in the coming years (that could lead to increased borrowing later) and a flawed communication strategy have not helped matters. The borrowing level is slightly higher than this fiscal (Rs4.51 trillion), but the two figures are not comparable. Last year the Reserve Bank of India (RBI) engaged in unprecedented open market operations to provide liquidity to frozen credit markets. This luxury will be unavailable this year. Plus the demand for money from private firms was low last year. It has picked up this year as the economy paces ahead. The expected increase in the policy rates by RBI, too, is on the radar of bond traders. When seen together, these factors have, and will continue to, keep the market jittery.

As Mint reported on Tuesday, the government plans to tell Parliament later this month how it overstated the revenue deficit figures due to an accounting classification problem. The government feels it has overstated the revenue deficit because part of the money was spent on creating infrastructure and not government consumption. This is akin to pulling the wool over the eyes of the markets.

The measure is addressed to rating agencies and tries to resolve the problems that Indian companies may face when they borrow money in overseas markets. Such efforts only create more confusion and uncertainty in the bond market. There are simply too many imponderables with such a strategy, if it can be called that. It may, if rating agencies buy the government line, ease borrowing for Indian firms abroad. But because it has the potential to roil the local bond market, they could make it harder for private firms to borrow locally.

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