By NR Bhusnurmath
In its Monetary Policy Statement on April 7, RBI announced it would obtain Rs 1 lakh crore of GoI bonds by way of the new G-Sec Acquisition Programme (G-SAP) and ‘unequivocally’ stated that ‘the Reserve Bank’s endeavour is to assure orderly evolution of the yield curve.’ Clearly reiterating its stand that low bond yields and a excellent yield curve will assure financial recovery even even though these are manipulated!
But is RBI’s contention valid? Do bond yields influence financial recovery in India? What does the information reveal?
These queries are not basically a matter of rhetoric. On the contrary, they are crucial since current auctions of government securities (G-Secs) have noticed yields inch larger, in spite of RBI’s attempts to hold prices down. On six occasions in FY21, in a 1st immediately after 2013, RBI rejected all bids. There is no mistaking RBI’s intent: It was a blatant try to manipulate what is supposed to be an auction-driven cost discovery course of action, presumably driven by the belief that reduced yields would translate into larger investment and therefore larger financial development.
At the exact same time, RBI has been conducting a series of ‘Operation Twists’ in a bid to reshape the GoI yield curve (plot of yields against maturity) in the hope that reshaping the yield curve would facilitate financial development.
Thus, RBI’s efforts have been two-pronged: To hold GoI bond yields low and simultaneously assure a ‘good’ yield curve (upward sloping) to facilitate financial development. Will it succeed? No.
Consider the 1st: The connection in between yields and development. Theories on connection in between bond yields and development beginning from Irving Fisher’s ‘The Theory of Interest’ in 1907 articulate, on one hand, that existing interest prices include data about anticipated financial development, and on the other, expectations of financial development influence bond yields. Studies in created economies indicate reduced bond yields precede financial development as reduced bond yields imply reduced expense of funds for investors, encouraging investment and, thereby, financial development.
The connection in between yield curves and financial development is more difficult. An overwhelming body of investigation suggests that though an upward-sloping yield curve indicates a expanding economy, the shape per se is not a causal element. RBI’s efforts to manipulate the bond marketplace to assure a ‘normal’ yield curve are, hence, somewhat surprising.
The ultimate test of no matter if these are probably to outcome in larger financial development is greatest gleaned by examining the information. An evaluation of last 10 years’ information does not show any inter se connection in between bond yields (with two quarter lag) and GVA development in India (see graph). Prima facie, this is baffling. However, one can scarce argue with the information. Hence, one demands to look beyond to have an understanding of why there is no connection in between bond yields and GDP development in India. The answer lies in the peculiarities of the Indian bond marketplace.
Bond markets can broadly be divided into two categories, the marketplace for sovereign bonds and corporate bonds. In created economic markets, each are integrated. But in India, thanks to a range of legacy difficulties, they are not. In truth, they are pretty disconnected. GoI bonds are virtually exclusively purchased, held and traded by banks and other economic businesses, mostly since of regulatory specifications like the statutory liquidity ratio (SLR). The secondary marketplace in GoI bonds is large, but it is nonetheless virtually exclusively dominated by banks and economic businesses.
In contrast, in spite of efforts to create the corporate bond marketplace, marketplace size remains somewhat compact. There are two causes for this. Since banks are major players in meeting borrowing specifications of businesses, they do not really feel the need to have to raise debt by way of challenge of bonds. Savers and investors look to have pretty small appetite thanks to larger perceived credit threat and lack of liquidity.
Given the significantly reduced dependence on bonds, bond yields have small to do with the expense of debt capital for significant businesses and are unlikely to influence their investment choices and financial development. Hence the absence of a connection in between bond yields and financial development.
As regards yield curves, a study of the information shows that there no correlation in between the shape of the yield curve (yields spread in between one year and 10-year bonds) and GDP development. Even immediately after introducing lags of up to two quarters, no connection is observed. Hence each theory and information do not help the view that the shape of the yield curve is a causal element. At greatest, it could predict financial development or recession, practically nothing more.
Thus, RBI’s assumption that artificially maintaining GoI bond yields low and manipulating the shape of the yield curve by way of Operation Twist and that bond yield and the shape of the yield curve is a causal element for financial development is not borne out by information. The only advantage is that it keeps the expense of GoI borrowing low.
The author is adjunct professor of Banking & Finance, IMT Ghaziabad