Bond yield rises nearly 6 basis points to a 24-month high of 6.52%

This raises the prospects of higher lending rates

The yield on the benchmark 10-year Government of India bond rose nearly 6 basis points (bps) to a 24-month high of around 6.52 per cent on Tuesday. This was the biggest one-day rise in bond yields in the last four months as bond investors asked for higher yields (or interest rates) in view of India's growing fiscal deficit and high inflation. The market closed on Monday with yields of around 6.46 per cent.

One bps is one-hundredth of a per cent.

"There has been upward pressure on bond yields in India for many months now, given the rise in bank credit-to-deposit ratio, higher inflation, and rise in bond yields in the US," said Dhananjay Sinha, managing director and chief strategist, JM Institutional Equities.

Gopal Tripathi, president and head-treasury and capital markets, Jana Small Finance Bank, said this event would not catch anyone by surprise. The yield on the benchmark has been moving up by a few basis points the past few days, factoring in inflation concerns and the trend of hardening in the global market. Monday's spike in US treasury yields has added to the momentum.

Overnight on January 3, 2021, the bond yield on 10-year US government bonds was up sharply by 8.3 per cent, or 12.5 bps, to a one-month high of around 1.64 per cent. The treasury yield in the US has more than trebled from its record low of 0.52 per cent reached in July 2020. This has put upward pressure on bond yields across the world.

The Reserve Bank of India (RBI) has, however, been wary of higher bond yields, given their negative consequences on the financing of central and state government fiscal deficit. Higher yields are also likely to translate into higher interest rates on corporate borrowing and retail loans that could obstruct the RBI's effort to stimulate India's economic growth through low interest rates.

This has resulted in a tug of war between the central bank and the bond market. Last Friday, the RBI canceled the auction of government bonds worth Rs 17,000 crore. Analysts attribute this to the bids (or the yields) from bond investors being higher than what the central bank was willing to give. A week ago, on December 25, bond auction by the RBI had devolved on primary dealers as investors were asking for higher yields.

The bond yields in the secondary market are back-calculated based on bond prices. Yields fall when bond prices rise and vice versa. In other words, investors sell their bond holdings when they are not satisfied with the existing yield and buy bonds when they are willing to accept lower yields.

With the latest move, bond yields are up nearly 62 bps in the last one year and up nearly 76 bps, from the record low of 5.76 per cent made in early July 2020.

This has raised the prospect of a rise in lending rate across the economy as the yield on 10-year government bonds acts as the benchmark interest in the economy.

“It does increase the cost of funds, but as long as rates do not spike beyond the digestible levels (around present levels), not many feathers will be ruffled. I do not think the government and the RBI will be worried about this level," said Tripathi.

Aditi Nayar, chief economist, ICRA, said yields moved up in the domestic market taking cue from the rise in the US paper. The 10-year benchmark yield could move up further to 6.7 per cent if the inclusion of Indian government securities in the global index does not happen. Also, another factor which could drive up yield would be the inability to meet the disinvestment target by the end of February. This could push the Union government to borrow more in March this year.

Investors choose hope over fear

The benchmark indices extended their gains during the second session of the new year as investors looked past the surging Covid cases and continued to bet on India's economic recovery. 

The Sensex ended Tuesday's session at 59,856, post a gain of 673 points or 1.1 per cent. The surge was led by Reliance, TCS, and finance majors in the index.