Moderate bond yield and significance

Context

The Reserve Bank of India’s decision to step up purchase of government securities under the government securities acquisition programme (G-SAP) led to the yield on the benchmark 10-year bond falling below 6%.

How the movements in bond yield impacts the interest rates?

• Movements in yields: It depends on trends in interest rates which can result in capital gains or losses for investors.
• If an individual holds a bond carrying a yield of 6%, a rise in bond yields in the market will bring the price of the bond down.
• On the other hand, a drop in bond yield below 6% would benefit the investor as the price of the bond will rise, generating capital gains.

 G-SAP and the bond yield

• G-SAP has engendered a softening bias in G-sec yields.
• The announcement of a bond-buying programme, the G-SAP has played a crucial role in turning the market sentiment
• The cancelling and devolving government debt auctions are giving tough signals to the bond yields.
• The fall in bond yields in India could also be due to a sharp decline in US Treasury yields or the economic uncertainty caused by Covid-19.

What’s the impact on markets and investors?

• A decline in yield is good for the equity markets because money starts flowing out of debt investments to equity investments.
• As the bond yields go down, the equity markets tend to outperform by a bigger margin and as the bond yields go up equity markets tend to down.
• The going up of bond yields show that corporates will have to pay a higher interest cost on debt.
• As debt servicing costs go up, the risk of bankruptcy and default also increases and this makes mid-cap and highly leveraged companies vulnerable.
• The yield on bonds is normally used as the risk-free rate when calculating the cost of capital. When bond yields go up, the cost of capital goes up.
• That means that future cash flows get discounted at a higher rate.
• This compresses the valuations of the stocks.
• Whenever the interest rates are cut by the RBI, it becomes positive for stocks.

Why RBI is keen on keeping yields in check?

• The RBI has been aiming to keep yields lower as it reduces borrowing costs for the government while preventing any upward movement in lending rates in the market.
• Any rise in bond yields will put pressure on interest rates in the banking system that will lead to a hike in lending rates.
• RBI wants to keep the interest rates steady to kick-start investments.

Where are yields headed?

• US monetary policy direction and Fed bond yields could be the biggest risk factors for the Indian bond market in 2021.
• During the “taper tantrum” episode of 2013, the Indian bond yields spiked and the value of the rupee collapsed within a few months.
• India’s macro position and external accounts are in much better shape than in 2013. Nevertheless, Indian markets will not be immune to any such shocks in the global sphere.
• Over the medium term, inflation and potential monetary policy normalisation will also play a major role in shaping the interest rate trajectory.