BL Explainer. Decoding the recent inversion in India’s yield curve

What is yield curve inversion?

The yield curve represents the yield or interest rates of bonds of similar quality across various tenors. Usually, the yield rises with an increase in the tenor of bonds. However, yield curve inversion occurs when the yield of longer-term bonds dips below that of medium-term bonds or the yield of medium-term bonds falls l below that of short-term bonds.

How did Indian G-sec yields invert recently?

The G-sec yield curve became inverted at the Friday weekly auction last week against the similar phenomenon in the US. and RBI accepting banks’ demand for higher yield at the auction for the medium-term G-Sec. But there was good demand for the longer-term G-Sec from insurance companies and provident funds at a relatively lower yield. At the last auction, the cut-off yield of the 2036 paper came in at 7.4527 per cent, while that of the 2062 paper came in at 7.3822 per cent. So, the yield curve became inverted.

What does it imply?

Experts say yield curve inversion could denote an impending economic recession or slowdown. However, this phenomenon may be short-lived once the demand for medium papers from banks increases. Currently, banks are demanding higher yields for medium-term G-Secs as a hedge against the likelihood of the rate-setting panel going in for a rate hike at its next meeting to tackle the sticky core inflation. However, after a year or so, the expectation is that there could be rate cuts to support the economy.

Which other countries have witnessed inversions in their yield curve in the recent past?

Twenty-nine countries, including the US, Canada, Germany, Singapore and France, have a ‘ totally inverted yield curve’, according to worldgovernmentbonds.com.

What steps is RBI taking to correct the curve?

The central bank will try to ensure that the yield curve slopes upwards as the tenor of G-Secs increases. Due to banks’ risk aversion for medium-term G-Secs, RBI, in consultation with the government, announced a revised calendar for March for the auction of Government of India Treasury Bills, increasing the demand for these securities. The government will be borrowing ₹1.95-lakh crore next month via T-Bills against ₹1.45-lakh crore notified in the earlier calendar.