RBI: Term premium at 12-year high pushing up borrowing costs
The premium is nearly 3%, the highest since 2010. This is driving up borrowing costs for companies that use the yield on 10-year bonds as a benchmark.
The Reserve Bank has kept its benchmark repo rate unchanged at 4% since May 2020. Meanwhile, the benchmark 10-year government bond yield, after remaining in a range between 5.85% and 6 .25% through September 2021, has since risen steadily to around 5.85% now. This translates into a term premium of 2.85%. With yield expected to increase by more than 7% in the next fiscal year, this could increase further.
“This indicates that the pass-through of RBI rate cuts to long-term interest rates remains limited,” said DK Joshi, chief economist at ratings firm Crisil. Investors priced in the fundamental pressures of a large fiscal deficit and high inflation, driving the term premium, he explained.
The RBI has always maintained a dovish stance and a status quo on policy rates, opting to wait for a sustained economic recovery. It did not raise its key rates although consumer price inflation reached the upper limit of the target range of 2 to 6%.
Unlike short-term yields, the benchmark 10-year yield is determined by the market, and while the RBI plays an important influential role, day-to-day movements largely reflect relative demand and market pressures. supply, economists said.
“While it is true that higher government yields will lead to higher corporate borrowing rates, some of them may simply reflect fiscal concerns,” said Rahul Bajoria, chief India economist at Barclays Capital. “In the current environment, where inflation risks are priced on the upside, the surge in term premia is not a big surprise and simply reflects market concerns about inflation,” he said. added.
The policy rate acted as a signaling rate in line with the RBI’s monetary policy stance, while short and medium-term yields moved in line with the central bank’s strategy, particularly the liquidity operation, according to market analysts.
“Term premiums in the interest rate market have been highly skewed across various segments. For example, the term premium between money market and three- to five-year yields has historically been the highest, due to the unprecedented liquidity of the system and the wide corridor between repo and reverse repo,” said Soumyajit Niyogi, Associate Director, Credit and Market Research at India Ratings.
“On the other hand, term premia between 10y and 20y+ are benign, in line with past trend, largely driven by favorable investor demand and the RBI’s twisting of the deal” , he added.