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A macroeconomic view of the shape of India’s sovereign yield curve

Summary:
Michael Debabrata Patra, Harendra Behera and Joice John in this RBI Bulletin article look at one of the contentious issue facing Indian economy: steep yield curve. The sovereign yield curve has a special significance for monetary policy in influencing a wide array of interest rates in the economy. Explicitly integrating macroeconomic variables with latent factors of the yield curve in a dynamic factor model, the results reveal that the level of the yield curve has undergone a downward shift from the second quarter of 2019, reflecting the ultra accommodative stance of monetary policy. Abundant liquidity is depressing short-term interest rates more than proportionately and steepening the slope of the yield curve, alongside a pick-up in issuances of ultra-long dated paper. Global policy

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Michael Debabrata Patra, Harendra Behera and Joice John in this RBI Bulletin article look at one of the contentious issue facing Indian economy: steep yield curve.

The sovereign yield curve has a special significance for monetary policy in influencing a wide array of interest rates in the economy. Explicitly integrating macroeconomic variables with latent factors of the yield curve in a dynamic factor model, the results reveal that the level of the yield curve has undergone a downward shift from the second quarter of 2019, reflecting the ultra accommodative stance of monetary policy. Abundant liquidity is depressing short-term interest rates more than proportionately and steepening the slope of the yield curve, alongside a pick-up in issuances of ultra-long dated paper. Global policy uncertainty impacts the slope and curvature of the yield curve, signifying the rising exposure of bond markets in India to global spillovers. Out of sample forecasts indicate scope for moderation of longer-term yields from current levels.

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The empirical results obtained in this paper indicate that a yield-only model tends to overpredict the level of yields across the spectrum except 6-8 years maturities segment (Table 2; Annex). Comparing actual yields for Q2:2021 (up to June 10) with the forecasts, the yield-macro model point to the scope for yields to adjust upwards by 1-23 bps in the 2-3 years maturity segment and downwards by 39-56 bps in the 6-9 years segment. It finds the 5-year yield to be fairly valued and the 10-year yield converging to fair value in Q2:2021. In Q3 (July-September 2021), the estimates show that there is further scope for the 10-year yield to ease from current levels. These evolving yield curve dynamics suggest the scope for open market operations and the points on the yield curve to which they need to be targeted.

Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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