Column: Why are GSec yields high?

Mar 06 2014, 02:47 IST
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SummaryThe GSec yields seem to be forward-looking, factoring in the state of liquidity expected in the coming months

Markets, as a rule, are filled with ‘noise’ which keeps analysts in business. Normally, we tend to say that the stock markets are whimsical and cannot be predicted. Otherwise one cannot explain how the Sensex has shown remarkable buoyancy during the year notwithstanding the relentless flow of negative news. The bond market also has assumed a rather unpredictable course with reasons being often ascribed post facto while conventional tools for analysis have not been able to deliver tenable a priori explanations.

The GSec market is probably one of the few active ones on the debt side and the 10-year paper is taken to be a proxy here. Typically, the yield should be reflective of liquidity conditions. The 10-year yield has been in the region of 8.8%, and while it was expected to come down with the rupee stabilising and liquidity conditions improving, things have not quite turned out that way. Last year at this time, the yield was around 7.8%, i.e., 100 bps lower.

Liquidity conditions prima facie look stable presently. Growth in deposits has been higher than that of bank investments and credit in incremental terms. The inflow of deposits through the

FCNR route has made this possible. In fact, this was not the case last year, where supply of funds through deposits was lower than the outflow through credit and investments thus necessitating affirmative action from RBI through the repo window. This time round, RBI continues to support through the repo, term repo and MSF routes. In fact, the overall outstanding amount through these combined routes would be about R70,000 crore, almost the same amount supplied last year directly through the repo window. This time round, RBI has channelled more funds through the term repo window which is understandable, given that the recommendations in the Urjit Patel Committee report, which speaks of the migration to the term repo as the signalling tool, are likely to be adopted.

Based on relatively stable liquidity conditions, compared to last year's, the GSec yields should have been moving downwards. The exchange rate too has been stable, unlike it was in the period May-September 2013 when high levels of volatility had prompted the market to panic. Also inflation has been coming down, which normally should have gotten buffered in the downward direction of interest rates. Last, despite all the pessimism expressed on the fiscal front, the government has stuck to the fiscal deficit target (in

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