Monetary policy: Rising yields a worry and RBI should act, say bond dealers

Rise in interest rates could hit corporate earnings, hinder economic recovery

The post-Budget rise in bond yields could hinder the fledgling growth impulses, and the central bank may have to once again assure the market that yields would be kept under check by providing ample support, say experts. 
 
Much of those assurances can be expected on Friday, when the Monetary Policy Committee (MPC) announces its decision on policy rates, which are likely to be on hold for an extended period. The bond yields have moved up at least 15 basis points after the Budget, closing at 6.10 per cent on Wednesday. The mood in the market has soured after the government said it would borrow Rs 12 trillion for the next fiscal year and an extra Rs 80,000 crore this fiscal year. 
 
For the better part of 2020, the yields have remained below 6 per cent. If the yields close the financial year at a substantially higher level, there would be heavy losses in the books. The Reserve Bank of India (RBI) has run a negative interest rate in the economy, and let the three-month borrowing cost dip to 3 per cent, far below the overnight policy rates. If the yields rise, much of those would be undone.
 
That won’t be good for the economic recovery.
 
“The larger-than-expected borrowing will put pressure on the yields and will eventually hinder transmission and crowd out private borrowing,” said Ashhish Vaidya, head of treasury at DBS Bank.

 
Still, mopping up of excess liquidity would continue as the market can function well with even Rs 2 trillion of surplus liquidity, against more than Rs 6 trillion now. 
 
The rise in interest rates could also hit the corporate earnings. Most companies, including banks and non-banking finance companies, reported a decline in their interest burden in the first nine months of FY21 (April-December 2020) following a sharp fall in bond yields.
 
For example, the lenders’ (banks plus non-bank) combined interest cost was up just 1.4 per cent year-on-year (YoY) during the nine months in fiscal 20-21 (9MFY21), compared to a 17.1 per cent rise for the same period a year ago. The lenders' interest cost in the December 20 quarter was the lowest in the last seven quarters even as the industry revenue reached a new high in the third quarter, a Business Standard analysis shows. This resulted in a sharp rise in lenders' interest margins and profits, going up nearly 27 per cent YoY (excluding Yes Bank numbers).
 
 Low interest rates also boosted the bottom line of mainline manufacturing and service sector companies. The combined interest cost of companies, excluding financial companies, was down 4.9 YoY during 9MFY21. This cushioned the blow from 15.5 per cent y-o-y decline in net sales during the period. This, in combination with a dip in raw material cost, allowed companies to report 9.2 per cent YoY growth in net profit in the April-December 2020 period. 
 
“India is trying to build a manufacturing base. A higher manufacturing cost because of higher interest components will make us uncompetitive," said Debendra Dash, head of asset liability management at AU SFB. “Global interest rates are low and any rise in interest rates will attract more capital, which will make the rupee appreciate and impact our exports.”
 
According to Gopal Tripathi, head of treasury at Jana SFB, interest rates would naturally rise with growth, and everyone would be prepared for that in the next year. “Given the economic recovery and that normalcy is returning, the RBI's tolerance level to keep the 10-year yield in check can go up by 40-50 basis points,” said Tripathi. 
 
But the central bank probably won’t let rates rise in this current fiscal year. The RBI gave some of these indications by cancelling the primary auction on January 22. 
 
“The market will be looking for the tone and guidance from the MPC and RBI, and how the central bank strikes a balance between keeping liquidity and managing inflation expectations along with the oversupply of government bonds,” Vaidya said. 
 
The RBI can technically increase the reverse repo rate from its current 3.35 per cent and at the same time give a larger amount through long-term repo operations (say, for one or three years) along with some periodic open market operations (OMO) calendar, Vaidya said. OMO is used to buy bonds from the secondary market to keep demand robust.
 
These measures can flatten the yield curve with the long end remaining well anchored and, thereby, not materially altering the borrowing cost for the government.