The yields on the 10-year bond rose to a six-month high of 6.93 per cent on Tuesday as crude oil prices spiked to $64 a barrel a day earlier on political tensions in Saudi Arabia.
According to bond dealers, crude oil prices worked as a catalyst for the yields, which anyway were on the rise. The 10-year bond yields have risen from 6.41 per cent in July to 6.93 per cent now even as the Reserve Bank of India (RBI) cut its rates once in August.
The market is under pressure for a number of reasons, the most important being the 200-basis point rise in inflation between June and August readings. Besides, the bank recapitalisation plans, excise duty cuts in oil process and farm debt waivers would widen the fiscal deficits of the Centre and the states, triggering extra borrowing. The banking system is also getting drained of its surplus liquidity and on top of that, the RBI’s open market operations to sell bonds in the open market are further drying up the surplus cash. Yields were to rise anyway under such circumstances.
However, the spike in crude prices is a clear case for worry for the market. Rise in crude prices, inevitably, will widen the fiscal deficit, which will have to be financed through market borrowing.
“Rise in crude prices is always a bad news for India,” said Harihar Krishnamurthy, head of treasury at First Rand Bank.
The scope for passing on the rise in crude prices to customers is limited, considering the prices in the retail market are already quite high and the government didn’t really pass on the benefits of lower crude prices to customers earlier. Therefore, bond dealers expect the government, or the oil marketing companies, to absorb the cost. This will widen deficits by a significant margin and the government could be prompted to borrow from the market.
“The yields may test the seven per cent mark soon, but whether it will sustain there is difficult to say. The yields are rising steadily and slowly, but there is no panic in the market,” Krishnamurthy said.