Reasons for rising bond yields

The jump came after the Reserve Bank of India (RBI) kept the repo rate, or the rate at which RBI lends to banks, unchanged at 4% in its latest monetary policy. The RBI is pursuing a liberal monetary policy to keep rates low to help the government, businesses and individuals borrow. No changes have been made on this front.

So it is surprising that the bond market wants higher returns than government bonds. RBI Governor Shaktikanta Das said, “In order of priorities, we have now put inflation ahead of growth. So far, Das had said inflation is transitory. However, the RBI’s inflation forecast for the current fiscal has been pegged at 4.5%. has been increased from 5.7%. First, a jump of 120 bps. As per its agreement with the Centre, the RBI is required to maintain an inflation target of 4% with lower and upper tolerance levels of 2% and 6% respectively. Inflation has been over 5% for most of the period from January 2020 to February 2022. Thus, inflation has not been transitory.

Much of this inflation has been driven by supply-side factors. Nonetheless, core retail inflation, which excludes prices of food and fuel products over which the RBI has no control, has been above 5.5% for most of the period since mid-2020. Furthermore, wholesale inflation has been over 10% since April 2021, forcing companies to raise prices. Globally, commodity prices have risen further since the outbreak of the Russo-Ukraine War. This will continue to impact retail and food inflation, which is not good news.

Despite this, the RBI has managed to meet the inflation target as the average inflation did not exceed the upper tolerance level of 6% for three consecutive quarters. Also it’s worth remembering that over the medium term, an inflation target of 4% is something that monetary policy needs to back the economy.

RBI is also the debt manager of the government. Its main goal from 2020 is to ensure lower rates to help the government borrow. It has done this by printing and pumping money into the financial system and lowering interest rates. Its cost has been borne by the savers. Inflation has been higher than interest on bank deposits for most of the period since the beginning of 2020. Lower rates can encourage borrowing, but can also hurt those who save and earn less interest, and this negatively affects consumption.

On Friday, the RBI acknowledged that inflation has become a problem due to the war in Ukraine. It plans to tackle this through ultra-housing, or withdrawing the money it prints, to keep rates low. There was a lot of excess liquidity in the system till 7th April 7.7 trillion. This came as a surprise to the bond market, which was betting on the RBI to help the government borrow at lower rates. With less money, interest rates will increase. Moreover, inflation estimates for the first two quarters of the current fiscal are 6.3% and 5.8% respectively, which means that the RBI is more than likely to increase the repo rate. The bond market is already downplaying this possibility, and that explains why bond yields have crossed 7%.

Finally, if the idea is to tackle inflation, why does monetary policy remain liberal? The RBI is apparently in no hurry to admit that it was slow to tackle inflation.