India's high 10-year bond yield is surprising, and yet not

Incoming Reserve Bank of India (RBI) governor Urjit Patel may find it worthwhile to take a look at why yield rates of India's 10-year bonds, better known as G-Secs or government securities, are high at 7.17 per cent.

We are the fastest growing economy in the world (7.6 per cent), with the sweetest-ever combination of inflation (4.9 per cent, 2015-16), fiscal deficit (3.9 per cent), current account deficit (1.1 per cent) and foreign reserves ($366 billion).

While Greece has the 10-year bond yield at around 8 per cent, the other so called PIGS (Portugal, Italy, Ireland, Greece and Spain) are seeing 10-year yields much lower than India's - Italy and Spain are at 1 per cent odd, while Portugal is at about 3 per cent!

In Latin America: Brazil is about 11 per cent, Venezuela at 11.52 per cent and Chile at 4.5 per cent. These three are also in economic distress. Venezuela is clearly a basket case. Chile too.

But yet their bond rates are at a low given their situation. (Chile has a lower debt: GDP ratio and a trade surplus.)

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Greece, the joker in the pack, has actually received assistance by way of loans and write-offs for private-sector bondholders to the tune of $450 billion.

It would seem that for these European Union nations, and a few other countries, while default risk premium has come off, the always-on liquidity tap of EU or international institutional backstopping is playing an invisible and subtle strategic role in keeping them low.

Ultimately, they are part of the euro and that says it all.

Naturally, the International Monetary Fund, European Central Bank and Germany are predisposed to bail out creditors who were German and French banks. And thereby avoid contagion within the EU banking system, and run on euro.

It's the same as loss-making public sector companies in India getting bank funding at prime rates! It would seem that one supports one's kind. And that is the only way one can explain this.

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It cannot be reiterated enough that these are stressed countries by any definition. And yet here is India clubbed along with Russia (8.3 per cent), South Africa (8.4 per cent) and Greece! Even Argentina is at 7.5 per cent yield (after defaulting on $80 billion in 2001), and Mexico at 5.8 per cent.

Surely, there is a huge difference between these economies. Imagine if we were in debt to the amount of Greece and had defaulted on payments and were in their economic situation. I wonder what our bond rate would have been then.

Perhaps there are perfectly cogent orthodox arguments to explain this.

Here are some:

1) We have a high fiscal deficit (about 6.6 per cent, if one includes the states) - this figure is highest among the emerging markets. 

2) Our inflation is not expected to be below 5 per cent. MPC or no MPC (Monetary Policy Committee). Indonesia is at 3.2 per cent and China at 1.8 per cent for CPI, while India is at 6.07 per cent (July 2016).

3) We lack a developed bond market (only 22 per cent of corporate funding is via the bond market and the rest is from banks, while this figure is over 50 per cent in developed markets).

Because of this, there is no alternate supply of decently-rated private/public bond market. So this is the only off-the-shelf long-life instrument. (However, this is changing with masala bonds and real estate bonds setting the pace).

4) Our statutory liquidity ratio requirement also impedes banks' ability to lend to corporates (again need to finance fiscal deficit).

5) Lack of capital account convertibility implies that there is a ceiling on foreign investment in bonds ($51bn). So global capital cannot freely flow in. On the other hand, there is ready demand for these sovereign assets, specially when the rest off the world is getting zero return on their other investment. (At last count, the value of bonds trading with negative yields reached $6.9 trillion, according to JP Morgan Chase.)

Uneconomics

Or, one could argue that yields on G-Secs are not the only barometer of risk premia. And it is now just a market clearing price for a "regular Joe" fixed income product, with good demand, which discounts for intrinsic risk. A one-eyed decent yield product in the land of low returns!

The real test will be if and when the US Fed hikes rates. The premia on yields will come off. But so will foreign monies. So the very rate which feeds inflow could see a ratcheting down of both.

In summary, one believes that India deserves a lower risk premium, and while part of it has happened, it should lend itself to "lower for longer".

But clearly, to my mind, our yields are high for being in one of the sweetest economic spots we have ever been on the 70th year of our Independence.