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2007 to 2017……Government Bond Yields….2018 !!! The road ahead

, January 9, 2018, 0 Comments

government-bond-yields-rbi-marketexpress-inThe Financial crisis of 2007 witnessed unprecedented and collective response from central bankers across the globe which was flexible, decisive and also local in nature to address the need of regional malaise. Aggressive reduction of Interest rates and flushing the banking system’s with abundant liquidity was the foremost and prompt priority of Central Banks. Key Interest rate approached near zero level in some countries, which led Central Bankers to be ready with unconventional measures targeting growth of broad money and infusing cash directly in the system outside the ambit of traditional monetary operations.

Active use of Central Banks Balance sheet in pursuit of influencing economic activity along with the use of conventional interest rate policy helped in asset price stability and tested and re-established the concept of “Lenders Last Resort” role of Central Banks. These unconventional measures more commonly known as Quantitative Easing (QE) altered the size and composition of the central bank’s balance sheet. In October 2014 when Fed Chairman Janet Yellen announced the end of the bond-buying program, the balance sheet size of US Fed touched $4.48 trillion from $869 billion in August 2007. Improving economic conditions with the lower unemployment rate, the uptick in stubborn inflation numbers and stable consumption data witnessed the reversal of the easy interest rate cycle in December 2015 by the Fed and since then the target benchmark lending rate has moved up to a target range of 1.25-1.50%.

The kind of turmoil, financial markets witnessed post the famous “Taper Tantrum” of 2013, emerging market economies like India, created enough doubts and uncertainties about the soft landing post unwinding of QE and reversal of easy monetary policy stance globally. The delay in actual implementation from 2013 to 2015 helped such economies to handle and be better prepared for the impact of the series of rate hikes by Fed this time. In sync with other central banks during Financial Crisis of 2007 the Reserve Bank of India and Government responded with easing of rates aggressively and extended fiscal stimulus measures in the economy. When QE tapering was first mooted in mid-2013, India looked vulnerable to rising inflation, stagnating growth and a current account deficit approaching 5% of GDP. Macro variables for India appears more stable and resolute as in 2017 taking the recent rating upgrades in its stride, though at the fag end of the year pressure on Fiscal deficit resurfaced with inflation also on an upward trajectory.

If we closely analyze the movement of the US Fed rate and Benchmark Repo rate in India, it will suggest that US Fed rate remained decisively low from 2007 to 2015 and was much more stable for a considerable period of time. That was not the case with the Benchmark Repo rate in Indian economy, which remained much volatile swinging from one end to the other reacting to domestic cyclical economic indicators and global headwinds. Establishing a balance between the Growth, Inflation and Interest rate remained the core challenge for the Governments and Central Bankers. While US economy was facing a sticky low inflation and low growth, Indian economy witnessed a stubborn high inflation for a considerable period of time keeping pressure on the interest rates and the domestic growth rate. The Goldilocks of high growth and low inflation, though appeared for small intervals intermittently, but was more teasing to the policymakers than any respite.

The Calendar year 2017 witnessed Fed continued hiking the interest rate backed by encouraging economic indicators, keeping the volatility of global financial markets in check and till date it seems a smooth transition unlike the disruptive danger of 2013 taper tantrum.Indian Bond market like other global debt markets anticipated the moves and tried to price in the prospective hikes in the yield curve.

But the onset of taxation reforms and persistence glut of bad debt in the Indian Banking system derailed the projected growth path in the short term and hence the fiscal math’s. The extra borrowing during the current fiscal year has put the Yields in uncomfortable zone spiking up to7.40%. The current spread between 10yr GOI and 10Yr US Treasury Bond stands out at 491basis point. Since 2000 till 2017 the maximum spread between the two was 709 basis points in Sep 2011 while 32basis point was the lowest in the summers of 2004. The average spread during the period figured out to be 422basis points.

The distinction between the interest rate in the US and Indian economy is that while the earlier is very well on the path of gradual upward trajectory the latter needs to avoid it. Any abrupt jolt to Indian GDP growth rate will have far reaching implications for the global economy, as India still holds the tag of being a bright spot in the global economy. Indian currency has shown remarkable resilience in recent times giving some respite to RBI though pressure on inflation has taken some sheen out of the comfort. Continuing reforms in 2018 coupled with fiscal discipline will keep Foreign Investors interested in the Indian economy and will help the Yield spread between 10Yr US and GOI to avoid breaching previous high’s.