10-year government bond yield
hardened to 6.23 per cent on Friday, up 0.05 per cent from 6.18 per cent on Thursday, February 25. So far in the month of February, the benchmark yield has risen nearly 1 per cent.
A rise in bond yield, generally, indicates expectation of an increase in interest rates
in the economy on the back of inflationary pressures. In January, CPI-based retail inflation came in at a 16-month low of 4.1 per cet YoY relative to 4.6 per cent in December, 2020 and 7.6 per cent in January, 2020. Core inflation ,however, remained unchanged at 5.3 per cent YoY.
"Although core inflation remaining sticky calls for some vigilance, headline inflation being close to the RBI’s medium-term target of 4 per cent is certainly a good sign. Therefore, the RBI's continued guidance to focus on growth – while ensuring headline inflation remains in check – suggests a rate cut is unlikely in the near future," said analysts at Motilal Oswal Financial Services.
Those at Emkay Global, meanwhile, said that risks of increasing input costs, higher commodity prices and seasonal upside in food prices and better pricing power remain key risks to inflation.
Against this backdrop, if the RBI chooses to increase interest rates
in the second half of CY21 then it would make lending rates costlier for banks. Consequently, the market also demands higher interest costs for the companies that want to issue bonds to meet their financing needs, as well as for the government.
That apart, a rise in bond yields would result in a loss for banks on their bond holdings (investment in government securities) which would be reflected as treasury losses in their balance sheets. To avoid this, banks will simply stop buying bonds which may result in the inability of the government to borrow cheaply in that case.
For the government, any fresh bond issuance has to be done at near the market yields. If the yields increase in the secondary market, the fresh issuance has to be done at a higher interest rate. This increases the interest cost for the government substantially. Therefore, the RBI will try to keep yields low, by supporting the bond market via OMO purchases and Operation Twist.
Taking this into account, the 10-year G-sec yield is likely to jump towards 6.15 per cent by September and further move up to 6.40 per cent by March 2022, believes Acuit Ratings, which expects a 25 bps rate hike going forward.
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