Why bond yields are rising


What the Reserve Bank of India (RBI) is struggling to achieve through multiple rate hikes in the past 20 months, the Indian government has done at one stroke—by announcing a 32% increase in its borrowing plan for the second half of the current fiscal year.
The yield on the benchmark 10-year bond rose to a new three-year high of 8.79% on Friday, a level last seen before the collapse of US investment bank Lehman Brothers Holdings Inc. Since the announcement of an additional Rs52,872 crore borrowing, raising the borrowing programme for the current fiscal to Rs4.7 trillion—the highest ever—the 10-year bond yield has risen 45 basis points (bps). A basis point is one-hundredth of a percentage point.
Also Read | Tamal Bandyopadhyay’s earlier columns
Typically, after every 25 bps rate hike, the 10-year bond yield goes up by 10 bps, and, on two occasions, when RBI raised its policy rate by 50 bps, the yield rose by about 30 bps each.
One way of interpreting this phenomenon could be that the fiscal authority has a greater influence on the interest rate architecture in India than the monetary authority. This is true about inflation control, too. RBI has not been able to reign in persistently high inflation and kill inflation expectations even after 12 hikes in policy rates because of the failure of the fiscal authority in addressing structural issues. Wholesale price inflation in September dropped to 9.72% from 9.78% in August, way above the banking regulator’s comfort level.

One reason behind the relatively mild impact of RBI policy rate hikes on bond yields could be the predictability of the rate hike trajectory. Instead of shocking and shaking the market once in a while, the Indian central bank has, so far, largely preferred to pander to the market expectations by its “baby steps”, or 25 bps rate hikes. The sudden announcement by the government on its higher borrowing programme lacked this predictability.
Apart from rising yields across maturities, there have been devolvements, too, on primary dealers who buy and sell government bonds. First, there was a devolvement of long bonds of 30 years and 15 years. This was followed by another 40% devolvement of 10-year and seven-year bonds last Friday. Under RBI norms, banks are required to invest at least 24% of their deposits in government bonds, but all banks have already been holding substantially higher bond portfolios and they do not have too much appetite for fresh buying. Besides, the government is also not too willing to offer a steep hike in yield in auctions as that pushes up its cost of borrowing. Bond yields and prices move in opposite directions.
The second-half borrowing now stands at Rs2.2 trillion instead of Rs1.67 trillion, and bond dealers suspect that even this will not be enough to bridge the fiscal deficit and there could be one more revision in the borrowing programme. R. Gopalan, economic affairs secretary, however, had said there would not be any change in the fiscal deficit projection, pegged at 4.6% of gross domestic product, and higher borrowing was needed because of lower government cash balances and a projected drop in small savings for the year.
The borrowing calendar put up on the RBI website shows the government will borrow between Rs12,000 crore and Rs15,000 crore every week. This is quite high and banks may not have that much cash to buy bonds if corporations start asking for money. Currently, the demand for project finance is quite muted, even though firms have been raising working capital loans. The year-on-year credit growth of the banking system is 21.4% till 30 September, but in the first half of the current fiscal, credit growth has been 7%. If credit growth picks up in the second half of the year, there will not be enough liquidity in the system to support such a high borrowing programme unless RBI decides to pump in liquidity by buying bonds from banks through its so-called open market operations. The system is currently running a deficit of Rs55,000-60,000 crore, about 1% of the banking industry’s deposits. This will go up later this month as people tend to withdraw money from banks during the festive season, leading to a rise in currency in circulation. One way of increasing liquidity could be a cut in banks’ cash reserve ratio (CRR), or the portion of deposits banks need to keep with RBI, but a CRR cut would be illogical when the central bank is following a tight money policy. Many believe it could even go for yet another round of rate hike later this month. More on this next week.
‘The Suicide Banker’
The Suicide Banker is the debut novel of Puneet Gupta, an assistant general manager with Samba Financial Group in Riyadh, Saudi Arabia, who had earlier worked with Indian banks. It’s a cocktail of suspense, sex, whistle-blowing and modern banking, and the influence of Chetan Bhagat on Gupta is pretty evident. I like the book not because of Gupta’s racy writing, but the near-perfect depiction of the soft underbelly of the banking business in India. Drawn from his own experience, he has documented how in their over-aggressiveness in cornering market share, banks throw all prudential norms to the wind. Loans are pushed down the throats of consumers and books are systematically fudged to inflate assets and profit and to postpone recognition of bad debts. Some of the incidents narrated in the book may seem too familiar if you know the industry well. The book is not great literature, but not a bad read if one wants to know why some Indian banks are going slow in customer acquisition and expansion of assets.

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