The premium is nearly 3%, the highest since 2010. This is pushing up the borrowing costs for companies that use the 10-year bond yield as the benchmark.
The Reserve Bank has kept its benchmark repo rate unchanged at 4% since May 2020. Meanwhile, the yield on the benchmark 10-year government bonds, after remaining range-bound between 5.85% and 6.25% until September 2021, has since risen steadily to around 5.85% now. This translates into a term premium of 2.85%. With the yield expected to rise over 7% in the next fiscal year, this could go up further.
“This indicates that pass-through of the RBI’s rate cuts to long-term interest rates remains limited,” said DK Joshi, chief economist at rating firm Crisil. Investors have factored in the fundamental pressures from a wide fiscal deficit and high inflation, causing the term premium, he explained.
The RBI has still maintained an accommodative stance and status quo on policy rates, choosing to wait for durable economic recovery. It has not raised key policy rates despite consumer inflation touching the upper end of the target band of 2-6%.
Unlike short-end yields, the 10-year benchmark yield is market-driven, and while the RBI does play a strong influential role, the day-to-day movements are largely a reflection of relative demand and supply pressures, said economists.
“While it is correct that higher government yields will lead to a higher corporate borrowing rate, some of it may just reflect fiscal concerns,” said Rahul Bajoria, chief India economist at Barclays Capital. “In the current environment, where inflation risks are being priced higher, the surge in term premia is not a big surprise, and just reflects market concerns around inflation,” he added.
The policy rate has been acting as a signalling rate in sync with the RBI’s monetary policy stance, while short-term and medium-term yields have been moving in tandem with the central bank’s strategy, especially liquidity operation, according to market analysts.
“Term premia in the interest rate market have been highly asymmetric in various segments. For example, the term premium between money market and three- to five-year yields has been historically the highest, caused by the unprecedented system liquidity 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 10 years and 20 years and above is benign, in sync with the past trend, largely caused by the favourable demand from investors and the operation twist by the RBI,” he added.
