The flattening of the yield curve read in conjunction with Inflation Expectations Survey of Households (IESH) suggests that inflation expectations are getting re-anchored after suffering multiple and overlapping shocks during 2022, according to the Reserve Bank of India’s (RBI) latest monthly bulletin.
It also reflects consensus expectations of slower growth in 2023-24 relative to a year ago – the RBI expects real GDP growth to moderate from 7.0 per cent in 2022-23 to 6.5 per cent in 2023- 24, with risks evenly balanced around this baseline projection, per an article in the bulletin titled ‘State of the Economy’.
The flattening of the yield curve is underscored by the fact that on May 12, 2023 yields on government securities (g-secs) ranging from 91-day treasury bills (t-bills) to the benchmark 10-year maturity security converged to a narrow range of 5 basis points (bps).
The authors (RBI officials) of the article observed that recent convergence reflects the confluence of policy actions by theRBI, spillovers from global monetary policy developments, elevated crude oil prices and safe haven flights.
Drivers of yield convergence
Domestic drivers include strong demand (for g-secs) from long-term investors, mainly insurance companies, pension funds and provident funds.
From March 2023, additional drivers of yield convergence are the forceful resolution of banking distress in some jurisdictions, the moderation or pause in monetary policy actions and the return of risk off sentiments.
“Short-term yields have been pushed up by sporadic tightening of domestic liquidity conditions due to skewed distribution of liquidity among market participants on account of asymmetric deposit mobilisation and differential liquidity and risk management practices followed by banks, increase in currency demand related torabiharvest operations, moderation in government spending and tax outflows,” the officials said.
The flattening yield curve may be indicating that financial conditions in debt markets – for which the g-secs yield curve is a benchmark – are neutral and, therefore, not a constraint for businesses looking to raise long-term resources, opined the officials.
Bull steepening
“This sounds like a positive for the prospects of private capex decisions, which can catalyse a ‘bull steepening’ of the yield curve signalling that inflation is vanquished and India is positioned on a growth trajectory that is consistent with its aspirations,” they said.
A bull steepening is phenomenon wherein short-term interest rates fall faster than long-term rates, resulting in a higher spread between the two rates and leading to a steepening of the yield curve.