The deviance in risk-free yields in India: What is driving the wedge?

Synopsis Despite monetary easing, low inflation, and soft crude prices, India's long-term government bond yields have risen due to increased government bond supply and global uncertainties. However, a moderation is expected as supply pressures ease and the RBI is anticipated to cut rates further. India’s long-term government bond yields have risen since June and remain elevated despite a troika of favourable factors—continued monetary easing, exceptionally low inflation and soft global crude prices. The Reserve Bank of India’s (RBI) Monetary Policy Committee has lowered the repo rate by a cumulative 100 basis points (bps) since February. The benchmark 10-year government security (G-sec) yield, however, has responded only marginally, with yield falling just 23 bps so far (on a monthly average basis). The benchmark yield did fall 46 bps on average between February and May, reacting to the rate cut, but has since rebounded a bit and stabilised. Meanwhile, inflation based on the Consumer Price Index (CPI) has surprised on the downside, averaging only 1.9% in the first seven months of this fiscal. October inflation printed 0.3%, the lowest in the current series since the 2011-12 base year. India’s banking system, too, has had comfortable liquidity. The RBI’s, net absorption (implying surplus) rose to Rs 2.2 lakh crore average in June-October from an average net injection of Rs 0.37 lakh crore in January-May. Live Events Crude oil prices—an important driver of inflation, interest rates and, hence an influencer for G-sec yield movements —are at four-year lows, averaging $67.9 per barrel thus far this fiscal. Yet the sovereign yields have risen. A closer look reveals two key forces behind the counterintuitive runup. First, higher supply of government bonds State development loans (SDL) issuances surged 21% on-year in the first half of this fiscal. With states front-loading their borrowings, supply pressures intensified. In the second quarter, states utilised 104.6% of their indicated borrowings amounts – significantly higher that 73.5% utilised in the first quarter, putting upward pressure on yields. The SDL yield touched 7.26% at the end of September, widening the spread over the 10-year G-sec to 70 bps, well above the 12-month average spread of ~45 bps. However, the SDL yield has seen some easing recently as issuances moderately slowed. Meanwhile, bank appetite for G-secs remains somewhat constrained given the large supplies. G-sec holdings as a share of bank deposits declined to 28.8% at the end of October from 29.7% at the end of the previous fiscal. Banks’ share in overall G-sec ownership reduced to 35.3% in the first quarter of this fiscal from 37.5% a year earlier. Second, protracted global uncertainties Broader geopolitical and trade worries have also nudged India’s domestic yields upwards as foreign capital flow remains volatile. Treasury yields in the United States have remained above 4% for most of this fiscal, contributing to a moderation in foreign portfolio inflows (FPIs) to India. FPIs net-invested just $2.9 billion in India in Indian debt markets in the first seven months of the fiscal, much lower than $8.8 billion in the same period a year ago. Looking ahead Despite the pressure, we expect the 10-year G-sec yield to moderate slightly to 6.4% by March 2026 from ~6.5% currently. Three factors should help: First, supply-side pressure on yields is expected to ease as borrowing / bond issuances (from centre and states) normalises in the second half of this fiscal. Second, we expect the MPC to cut the repo rate by another 25 bps in its December policy review due to a benign inflation outlook. We expect retail inflation to average 2.5% this fiscal, a good 200 bps lower than last fiscal, owing to soft crude oil prices, expectations of healthy food supplies, and the rationalisation of goods and services tax. To be sure, the repo rate is already near its long-term average—at the decadal average (5.5%) and below the 5-year average (5.7%). The benchmark yield, on its part, is lower than both its decadal average (6.8%) and 5-year average (6.9%). Third, supportive macro factors will persist. A 100-bps cut in the cash reserve ratio, in four tranches of 25 bps each, between September and November, will continue to keep liquidity conditions comfortable. Crude oil prices are expected to remain subdued amid global demand concerns and ample supply. Even though FPIs remain cautious, some factors could provide relief. S&P Global expects the US Federal Reserve to cut its federal funds rate by another 25 bps this year, which should soften US treasury yields. A potential US-India trade deal could also reduce tariff-related uncertainty, supporting FPI flows into India. The recent deviance in India’s risk-free yields may appear puzzling at the first glance. But a closer look reveals supply-side factors have outweighed macro tailwinds in the near term. Even so, the broader macroeconomic setting continues to provide a firm anchor. (Dipti Deshpande is Principal Economist and Sharvari Rajadhyaksha Junior Economist at Crisil. Views are personal) (You can now subscribe to our Economic Times WhatsApp channel) (Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.) How a Sebi report reopened Indiabulls-YES Bank saga that was fading Ever wondered why cos' financials look good before IPO, but not after? From near collapse to INR50k cr value: The journey of MCX AI is forcing a rethink. Can Indian IT finally build a serious corporate VC muscle? Stock Radar: 20% rally in 1 month! BHEL breaks above falling trendline resistance to hot fresh 52-week high Weekly Top Picks: These stocks scored 10 on 10 on Stock Reports Plus 1 2 3