Why Government bond yields have suddenly started rising here in India?

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in

I think retail investors in India can never make money out of any market-linked financial asset, be it stock market or debt market or forex market or gold. Our past experience in the stock markets has been very bad and even with extremely difficulty, you’ll hardly find any Indian investor who is 100% convinced that there is a scope for the retail investors to make money in the Indian stock markets.

It is quite natural that most of the investors will always invest their additional surplus in an asset class which has given highest returns to them (or general public) in the recent past. Investment in gold is the best example. Gold prices have crashed dramatically in the last 3-4 months. Around Diwali last year, gold prices crossed Rs. 32,000 and people in India have this mindset that gold prices always rise. They also have a view that around festivals like Diwali and marriage season during October-November, gold prices usually rise even more. Even after a sharp fall from its all-time high of $1917.90 in August 2011 to $ 1223.54 in today’s trade, you could still find many people having these kinds of views.

After a sweet & swift rally in the Indian bond markets, the Indian retail investors had just started investing in the long-term debt securities like gilt funds or income funds in an anticipation of a further rate cut. A mild economic recovery in the US and Japan has once again shattered the hopes of Indian retail investors.

Indian Rupee has been falling like never before. The rupee today breached an all important psychological mark of 60 against the US dollar and now it has fallen by approximately 12% in the last 2 months itself. Reason – Fear of foreign institutional investors (FIIs) pulling money out of Indian debt and equity markets even faster, which they have been doing very fast in the past 3-4 weeks.

At a time when we badly require foreign investments to pour into Indian markets due to a very high current account deficit (CAD), FIIs have decided to turn their taps off.

After pumping in $15 billion in the Indian markets in 2013, FIIs have decided to book their profits here in India (and also some other emerging markets) and switch their investments to their own countries or to those economies where they are foreseeing more stability in terms of economic and political decision-making. FIIs have pulled out some $5 billion from the Indian debt markets since May 21st this year.

The situation is so bad that the analysts who, at the start of this month, were expecting the RBI to cut its policy rates on June 17 to help economic growth recover somewhat, have started issuing reports stating that RBI may even be compelled to raise rates in its efforts to protect the falling rupee.

It is a vicious cycle. One factor is playing its role in the other factor becoming worse and then itself getting worst due to some other factor coming into the picture. Slow economic growth, high current account deficit and poor economic decision-making are putting huge pressure on the Indian currency and thus forcing FIIs to pull their money out of the Indian equity and debt markets, thereby putting even more pressure on rupee.

A falling rupee would make our imports costlier, which would again fuel inflation on a higher side and thereby forcing the RBI to increase its policy rates in order to reduce liquidity from the system and save the rupee from a further fall. Ultimately, it would result in a higher yield on Indian government securities (G-Secs) and more losses for the retail investors.

India 10-year Govt. Bond Yield

US 10-year Govt. Treasury Bond Yield

Japan 10-year Govt. Bond Yield

Look at the charts above. If we are able to keep the Indian rupee stronger, clearly our debt markets have been extremely attractive to the foreign investors as there is a huge yield difference between Indian govt bonds, US treasury bonds and Japanese govt bonds.

At the beginning of April this year, the 10-year Indian govt. bonds yield was ruling at around 8%, the 10-year US treasury bond yield was at around 1.75%, a huge gap of approximately 625 basis points (bps) and the Japanese bond yield was at around 0.57%, an even bigger gap of approximately 743 bps.

After that, Indian govt. bond yield fell sharply to touch 7.09% in May, whereas US treasury yields rose to 2%, thereby narrowing the yield gap to just 509 bps and Japanese yields inched closer to 1% mark, thus making Indian govt bond yields extremely unattractive to the foreign investors amid USD and Japanese Yen becoming stronger and Indian rupee losing its value.

By late May & June, after the announcement of QE tapering by the US Federal Reserve, the US bond yields have jumped even sharper, crossing 2.60% mark on June 25th, making it more attractive to the long-term US investors and the yield gap has gone below 500 bps. Moreover, US and Japanese investors would like to invest in their own country in order to avoid risks related to currency and other geopolitical factors.

At this point in time it is the topmost wish of our finance minister P Chidambaram that Indians should stop purchasing gold for some time and thereby help our country fight the continuously rising current account deficit. I think it becomes our duty to listen to his appeal and stop purchasing gold till the time we are able to stem this huge current account gap.

It is yet to be seen when and where this yield rise will stop, but India badly requires a benign interest rates regime in order to kickstart the economy again.

11 thoughts on “Why Government bond yields have suddenly started rising here in India?”

  1. Hi Harineem,
    The word ‘SIP’ is overhyped. SIP is just a way to invest in equity, debt, gold or any other asset class. For retail investors who just dont understand abc of volatile asset classes and who cannot do basic investment research, SIP is recommended. The way the retail investors invest here in India, through sales agents of banks in the form of RMs or without giving deep thoughts to it, one should never invest in equity SIPs.

    For other investors, who have money to invest, there is no harm in doing lump sum investment and I think it is still one of the better times to invest in equities. With current valuations, one can invest a certain % of his/her investments in equities, depending on his/her risk appetite. 2-5 years from here, I think equities should comfortably outperform real estate, gold, debt, commodities etc. I am not scared of global economies melting down. I think India is a great country with huge potential. The only problem is politics, politicians and corruption.

    The way the NDA govt sold PSUs was a much better way of doing disinvestment rather than the way the current UPA govt is doing it. It is selling its assets at dirt cheap prices and making these PSUs more inefficient by keeping their control with itself. Check the performance and the share prices of these PSUs in the last 3-5 years and you’ll get to know that none of these Ratnas & Maharatnas of the world performed to their full potentials. I wonder what do we eat/drink on a voting day to elect such inefficient politicians and why we always keep quiet when a corrupt officer asks for a bribe.

  2. Do you do any currency trading? I am not reading too good reviews on etoro. Please advise any good online trader.Might be a good option now that equity/debt all are low.
    One query: Shiv do you advise your customers to still stick with SIPs in debt and equity considering the worsening scenario?

  3. A very informative and useful article.Particularly the charts are great.Used as I am to 9-10% interest regime I have always wondered how the US and Jap investors are happy investing at the ridiculously low 1.5 to 2.5%.Can you please through some light on this?
    OK now what is the advice you give to retail investors like me?Should we exit from GILT and INCOME funds which gave us around 13% and put it in Bank FDs at 9%?

    1. Thanks Mr. Ramamurthy!
      These charts are courtesy Bloomberg.com, I forgot to mention it in the post itself.

      Yields on the government securities, 7.56% here in India, 2.54% in US, 0.84% in Japan etc., depend on many factors. I’ll try to cover those factors with a post sometime soon.

      From 1-2 years’ perspective, I still think that interest rates, bond yields should move lower from the current levels and hence one should stay invested in the Gilt, Income funds. There is an opportunity for those who missed the rally in the bond markets in April and early May. For very short-term period, short-term funds might prove less riskier.

    2. They also have ridiculously low inflation of 1-2% with the risk of deflation. So, real rates not that different in both countries. Secondly, half of the S&P 500 (top 500 companies in the US by market cap) revenues come from outside US. And, most investors have global exposure through those companies and/or directly investing in other countries. Countless international, emerging etfs and funds available to retail investors in the US.

  4. Hello, since when did it become the duty of citizens to obey politicians, that too failed and corrupt ones? If the govt had its act together, he wouldn’t need to make ludicrous requests. Lets just ask him to do his job first before he goes about asking for favors from citizens.

    1. Hi Shaviv,
      It is definitely not our duty to obey politicians blindly. I think a move to control high CAD by not buying gold is a matter of national interest and PC is probably not asking for any personal favors here.

      I agree with you that this UPA govt. has failed to do its job on each and every front and probably most of these people just dont deserve to be our national leaders. But, not all are alike. Whatever this govt deserves, it will get in the upcoming elections of four states (Delhi, Rajasthan, Madhya Pradesh and Mizoram) in November and the general elections sometime around April-May next year.

      1. Let me clarify, even though its a bit tedious.

        a) I didn’t say the matter is not of national interest. b) I said that the request by PC is ludicrous. Those are two different things.

        There are a million things that are of national interest and/or which can be done to control high CAD. Stupid restrictions on free citizens is not one of them. To some extent, he is asking for a personal favor, or rather, asking for support for a short term measure which suits his short stint in office, until elections.

        If the public doesn’t allow the govt such stupid ideas, they might actually have no option but to do the right things for the long term. In other words, we need to stop letting the govt take citizens for a ride and avoid letting them take short term measures all the time. We are where we are as a result of countless such short term fixes. At some point, we have to stop and change the long term fundamental economic policy. In 1991 we were forced. We can wait for another moment like that, which by the way, the economists have been warning for a year or more. So, the question is where was PC’s concern for the national interest since then?

        So, again, yes it is an issue of national importance, but I don’t agree with PC and short term measures which would be a counter-productive solution.

        As far as, whether the govt gets what it deserves in future elections, I’m not as optimistic as you are. Needless to argue why, but given the abysmal choices and results out of elections, there isn’t much to hope for. Incidentally, democracy is not always a good framework for accountability (unless we have educated citizenry), which is why you need the constitution and the republic. Unfortunately, those are compromised as well, but as the SC has shown, some good things can still come out of the Indian republic, even while Indian democracy is merely another name for kakistocracy.

        I’d rather consider what the economists are saying, instead of listening to a stupid politician trying to get to the next election. It would be the proper, qualified way to respond to PC’s ludicrous request: http://ilapatnaikblog.blogspot.in/2013/06/how-to-cap-cad.html

        1. I agree with your thoughts. I think Indian politics has become quite dirty and it is very difficult to find leaders who work for the nation and humanity. But I think PC is not the right person to be blamed for the current bad condition of Indian economy, rather it was Pranab Mukherjee (PM) who should be blamed for his inefficiency as the former finance minister. It was PC who left Indian economy in good condition when PM took over and it was PC only who turned around business sentiment when he reacquired his portfolio last year in September. It is the media and impatient investors who have been putting a lot of pressure on the ministries to take quick decisions (or probably short-term measures). I think policy measures should not be taken in a panic but should be dynamic & quick at the same time.

          1. Nope, I do not agree. In PC’s previous stint, he did a lot of bad things. In this current stint also, he hasn’t done much. The proof is in the pudding. Yes, he may have done SOMETHING, but that’s hardly saying much. The architecture of the economy needs an upgrade. Large difference here. Yes, he might be marginally less hare-brained than PA, but again that doesn’t say much. PC is better educated than PA in modern economics, yet he hasn’t done some very fundamental things that were commonsense, even per the recommendations of the finance commission. This is evident in his comments on the RBI, and again his ludicrous suggestions, and on and on. In that light, I would consider PC’s failure (across all his previous and current stints) larger than PA’s, because PC is smarter than PA and should know much, much better.

            In any case, it hardly matters who is to blame, the point was that PC shouldn’t be making stupid suggestions, so the point is irrelevant.

          2. And, even while PA was FM, MMS and PC have been in the GOM and big decisions are discussed and approved in GOM. So, its not like MMS and PC had no responsibility during PA’s tenure.

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