MUMBAI: Why have loan rates not dropped much even after RBI’s cuts? Bond markets are partly responsible for the slow transmission. Bond yields are rising even as the central bank is cutting rates – this divergence is unusual. Why the rise in yields? Long term inflationary expectations, closing of an important liquidity channel for the banking industry (open market operations, or OMOs) by RBI, and expectations of marginal cut in rates have combined to keep the benchmark yield on 10-year govt bonds at an elevated level.This in turn has hurt the transmission of rate cuts to borrowers as banks and other lenders have not cut interest rates on loans as much as RBI and govt had expected they would. Hence, govt and RBI are worried that the rate cut transmission has stalled. Although the consumer inflation for July was at 1.6%, a multi-year low level, market players expect this to start rising soon. “Bond investors desire protection against inflation. While current inflation readings are low, expectations about future inflation remain elevated,” said Sandeep Bagla, CEO, Trust Mutual Fund.On Aug 6, RBI said that consumer inflation for FY26 is projected at 3.1%, going up to 4.9% by the first quarter of FY27. “Ironically, reducing repo rates and increasing liquidity support growth in the short term, but can be seen to fuel inflation in the long term. Globally, bond yields are going up despite central bankers cutting short term rates. Bond markets are telling us that they expect inflation to go up and remain elevated in the medium to long term,” Bagla said.Despite RBI’s cut in policy rates by 100 basis points (equal to one percentage point) since Feb this year, the yield on 10-year gilts has risen. From 6.23% on June 6, the last time the central bank cut policy rate (by 50bps to 5.5%), bond investors have been bearish on govt securities. As a result, the benchmark yield on Friday closed at 6.59%. Bond yields and prices of these instruments move in opposite directions. Rise in bond yields while the central bank is cutting rates is unusual. A report by Axis Mutual Fund’s fixed income head Devang Shah, termed this phenomenon of rising benchmark yields despite cut in rates, supportive macroeconomic scenario, and improved sovereign ratings, as a “notable dislocation”. “This divergence stems from structural imbalances, evolving fiscal expectations, and shifting regulatory dynamics,” Shah said.A section of the bond market players is also worried about the expected revenue losses for the central and state govts from the ensuing cut in GST rates. The question for them is if the govts will go for higher borrowing to make up for the revenue loss.
