RBI WANTS TO MODERATE BOND YIELDS

RBI WANTS TO MODERATE BOND YIELDS

Subject : Economics

Context : 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%.

Concept :

Current movement of Bond Yields

• The yield on the 10-year benchmark 5.85%, 2030 bond fell by 0.62% and closed at 5.978%.
• The RBI under G-SAP has so far bought Rs 25,000 crore worth of government securities (G-secs).
• The 10-year bond has declined 15 basis points from 6.15% in the last one month.
• The movements in yields, which depend on trends in interest rates, can result in capital gains or losses for investors.
• It implies that 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.
• A drop in bond yield below 6% would benefit the investor as the price of the bond will rise, generating capital gains.

Factors affecting the yield:

• Monetary policy of the RBI (interest Rates), fiscal position of the government and its borrowing programme, global markets, economy, and inflation.
• A fall in interest rates makes bond prices rise, and bond yields fall.
• Rising interest rates cause bond prices to fall, and bond yields to rise.
• So, a rise in bond yields means interest rates in the monetary system have fallen, and the returns for investors have declined.

Impact of low bond yields on markets and investors

• The experts say that the structured purchase programme has calmed investors’ nerves and reduced the spread between the repo rate and the 10-year government bond yield.
• A decline in yield is also better for the equity markets because money starts flowing out of debt investments to equity investments.
• It implies that as bond yields go down, the equity markets tend to outperform by a bigger margin and as bond yields go up equity markets tend to falter.
• It says the yield on bonds is normally used as the risk-free rate when calculating the cost of capital.
• It implies that when bond yields go up, the cost of capital goes up.
• When bond yields go up, it is a signal that corporates will have to pay a higher interest cost on debt.
• The risk of bankruptcy and default also increases as debt servicing costs go higher and this typically makes mid-cap and highly leveraged companies vulnerable.