Without too many people noticing, Indian 10-year bond yields have dipped sharply down to the 2009 lows. At around 6.6%, the 10-year G-Sec yield is lower than the levels we had seen at the peak of the global economic crisis in 2009. What is different is the correlation between the repo rate and the 10-year G-Sec yield. Back in 2009, the 10-year G-Sec yield was at this level when the repo rates were at 4.75%. Today the 10-year G-Sec yield of 6.6% is being supported by a much higher repo rate of 6.25%. Despite the 150 bps difference in repo rates, the yields are almost at the same level. What explains this sharp fall in 10-year yield?
So how exactly have these yields moved? Yields peaked this year at around 7.87% in February when the equity markets were about to begin their rally post the Union Budget. Subsequently, there were two key points when the yields fell sharply. Firstly, the yields fell sharply around mid-June when Dr. Raghuram Rajan announced that he would not be seeking another term as the RBI governor. The second sharp fall came in September when the new RBI governor took over and it was evident that future monetary policy will be driven by the Monetary Policy Committee (MPC) where the RBI governor will not have a veto any longer. There were 6 key factors that have driven yields in recent months.
Change of guard at the helm of the RBI
Despite the previous RBI governor, Dr. Raghuram Rajan, cutting repo rates by 150 basis points between January 2015 and September 2016, the industry leaders and the market participants were broadly disappointed. Industry was of the view that the shift by the RBI from rate setting to liquidity management was not in the interests of industry. While Dr. Patel is also known to be a hawk, people are reposing much greater hope on the Monetary Policy Committee (MPC). The MPC is equally represented by the RBI and the Government nominees and therefore the hope is that there will be greater focus on growth rather on price stability alone. This is one of the key factors driving yields down.
Monetary Policy language has avoided a hawkish note
The last monetary policy in October and the one prior to that in August had clearly avoided adopting a hawkish stance. This approach is important because it opens the doors for further rate cuts. Of course, rate cuts in December this year may be slightly far-fetched as the US Fed is likely to meet in mid-December to take a call on Fed rates. But if the Fed does not get too hawkish, it surely opens the door for the RBI to cut rates in its February meet. The dovish tone is one more reason for the fall in yields.
Inflation shows promise on the way down
The one factor that is the key to long term rates in India is the inflation rate as well as the expected inflation trajectory. The month of August has seen CPI inflation fall sharply from 6.07% to 5.05%. This has substantially lowered inflation expectations for the coming year and paved the way for further rate cuts. More importantly, food inflation which is the stickiest component of CPI inflation has shown a sharp fall by 300 basis points in the month of August. A good monsoon is likely to result in a bumper Kharif harvest this year. Low inflation expectations are a key factor in leading to G-Sec yields trending downwards.
RBI has made abundant liquidity available
Another reason for the sharp fall in 10-year G-Sec yields has been the liquidity support that the RBI has given to the short end of the yield curve through open market operations (OMOs). This abundant liquidity infusion has been instrumental in bringing down yields sharply at the short end of the yield curve. The sharp fall in yields at the short end skewed the yield curve to bring down yields at the long end too. The RBI has, in fact, shifted the money market from a liquidity deficit to a neutral situation. That has also been a key factor in bringing down yields on the 10-year G-Sec.
Huge demand from domestic institutional investors
Since the beginning of the current fiscal year, domestic institutional investors have infused over $50 billion into Indian debt. This huge demand for Indian debt has kept debt prices buoyant and depressed yields on the 10-year bonds. Domestic investors are getting increasingly cautious on equity due to high valuations but see opportunities in debt. That is ensuring that inflows into government debt remain buoyant.
Global demand for Indian demand will return
Global investors have not been major investors in the Indian debt market in the current financial year. This can be partly attributed to FIIs being close to their investment limits and also because there has been some shift towards other markets. However, it needs to be remembered that Indian yields are still very attractive considering that nearly $13 trillion worth of global debt still carries negative yields. With the INR remaining steady, the FII interest in Indian debt will remain high.
The 10-year G-Sec yields are headed further down. That makes investing in Indian debt paper still attractive. The big India debt story may have just about begun.