Why exactly have yields fallen so sharply to multi-year lows as indicated in the chart above? Also, what could be the implications of this fall in yield?
Why have bond yields fallen so sharply in India?
With the December quarter GDP growth coming in at 4.7%, the RBI had assured the markets that it would be willing to do everything to boost growth in the short to medium term. This statement must be combined with the decision of the MPC to keep the monetary stance accommodative. It hints at RBI willingness to cut rates further. This has pushed down yields sharply in the last one month.
Secondly with the Coronavirus pandemic spreading across countries, most central banks are bracing for pre-emptive rate cuts. The US Fed already took the initiative and cut the rates by 50 bps on March 02, 2020. The sharply lower yields indicate that the RBI could follow suit on rate cuts, although the move may be more calibrated due to inflation concerns.
Thirdly, markets are expecting CPI inflation to ease gradually. The Rabi crop in 2019-20 is expected to be 9% higher than the previous year. Also, with crude oil closer to $52/bbl, the markets are expecting the downstream effect of weak oil prices to manifest in lower inflation. This is one more reason that is leading yields lower.
But, why are yields at multi-year lows?
The last time 10-year bond yields in India touched 6.23% was nearly 40 months back in November 2016 in the aftermath of the currency demonetization. In fact, the last time the bond yields dipped below 6.20% was in 2009 at the peak of the Lehman crisis. If you go back to the past 25 years of Indian bond yields, they have been below 6.2% only on 2 occasions; in 2004 and later in 2009. To understand why Indian bond yields are at multi year lows, we need to look at the US 10-year bond yields.
When the US bond yields dipped below the 1% mark on 03rd March and touched 0.97%, it was the lowest bond yield level in the last 100 years. As the chart above shows, it has never been this low. Indian bond yields have traditionally maintained a 400 to 450 basis points yield gap in the past. With the aggressive rate cuts by the US Fed and the fears of an economic slowdown, US bond yields are under pressure. That pressure is having a collateral impact on Indian bond yields too.
What do sharply lower bond yields mean?
Broadly, there are 3 implications of sharply lower bond yields as far as the Indian markets are concerned.
- A sharp fall in bond yields results in appreciation in bond prices. That is good news for most banks as they hold large chunks of long dated government securities that are the biggest beneficiaries of falling bond yields. In addition, debt funds could also end up being gainers. In 2019, repo rates were cut by 135 basis points resulting in bond funds being among the best performers.
- Equity markets normally tend to benefit from lower yields. That is because it reduces the cost of debt and hence the cost of capital. Since the cost of capital is used to discount future cash flows to value stocks, this has a positive impact on stock prices. In fact, that could be a good reason for the stock markets to revive after the carnage caused by the Coronavirus.
- Finally, lower yields means that cost of borrowings come down. This will be positive for Indian companies as they can reduce their cost of borrowings and the stress on their balance sheet. However, there is a catch here. If this fall in yields is triggered by a slowdown in growth, then the impact could be the exact opposite.
As the PMI services and the PMI manufacturing show greenshoots of recovery, industry needs low yields to bounce back. It is now over to corporate growth to work the magic!