Mumbai: The Reserve bank of India (RBI) on Friday said that rising bond yields could undermine fragile global economic recovery in a challenging environment leaving most economies unable to withstand the impact of high interest rates on households and businesses alike. In its latest bulletin on currency and finance for the month of March, RBI said that while it is doing all that it could to ensure an orderly evolution of the yield curve, bond vigilantes could, however unsettle financial markets and trigger capital outflows from emerging markets. RBI said that while there is a restless urgency in the air in India to resume high growth, the bond market has been unyielding so far despite its efforts. RBI maintained that the Indian economy is in a critical juncture currently, where the capex cycle is uncoiling and turning, and earnings results of corporates emerging from the pandemic induced slowdown has beaten market expectations, Inflation too has witnessed upside pressures.
Domestic bond yields have risen steadily ever since the union budget announced additional borrowing programmes of ₹80,000 crore for this financial year and of ₹12.80 lakh crore for next year. The yield on the 10 year benchmark bond has been increasing despite RBI’s assurances and efforts to keep the yield below 6%. To stem the yield curve, the central bank has periodically conducted open market operations( OMO), buying and selling government securities of varying tenors. Additionally, the RBI has on several occasions directly intervened in the secondary market to smoothen the yield curve. So far this fiscal year, the RBI has undertaken OMO purchases of G-Secs worth ₹4.07 trillion, besides OMO purchases of state development loans of ₹30,000 crore. On 25 February RBI Governor Shaktikanta Das urged cooperation from bond market participants for the “orderly evolution of the yield curve". He had also assured that the central bank will not drain liquidity prematurely to stifle growth.
In a chapter on the State of the economy, the central remarked that the economic revival which is gradually being built with the help of regulatory forbearance is being threatened by the bond market. In a veiled threat, the central bank said that it can increase bond purchases if the yield goes on increasing.
“If bond yields get too high, the relentless weight of bond purchases by central banks will stabilise markets, but at the cost of market activity. The recent reiteration of the resolve of the Reserve Bank of Australia is a reminder that central banks have the firepower to cap bond yields, if they are determined to do so. Investors must understand their exposures when they set about to scour the landscape to exploit signs of market dysfunction. What markets do not realise beyond the break evens, TIPS and policy stimulus is that there is no way the economy can withstand higher interest rates in its current state," it said.
RBI also noted that there are ominous signs of a second wave of infections. India added almost 40,000 new cases on Friday, the highest one-day jump since end of November, pushing the overall tally to 11.5 million, according to the health ministry data. RBI also said that inflation is also seeing upside pressures. Consumer Price Inflation has moved in a tight range of 5.8 to 6.4 per cent from June, testing the upper tolerance band of inflation target, it said.
Further RBI added that there a restless urgency in the air to resume high growth. The incoming data point to even contact-intensive services such as personal care, recreation and hospitality gathering traction. Agriculture production has crossed highs in various crops and in horticulture, while manufacturing has shrugged off the vice-like grip of contraction. “All around, optimism is taking hold, among households and businesses, investors and markets," the bulletin said.
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