Challenges in Bond Markets Hinder Banks from Passing Rate Cuts to Consumers
MUMBAI: Despite recent cuts in interest rates by the Reserve Bank of India (RBI), loan rates have not seen a significant decrease. This anomaly is largely attributed to rising bond yields, which have remained elevated even as the central bank aims to stimulate the economy. Factors such as long-term inflation expectations and changes in liquidity channels have contributed to this unusual situation, raising concerns among government and financial authorities about the effectiveness of monetary policy.
Bond Market Dynamics
The bond market is experiencing a divergence that is impacting the transmission of RBI’s rate cuts to borrowers. Typically, when the central bank lowers rates, one would expect a corresponding decrease in loan rates. However, the current scenario is different. Bond yields have been on the rise, with the benchmark yield on 10-year government bonds closing at 6.59%. This is a notable increase from 6.23% following the last rate cut in June. The unusual rise in yields, despite the RBI’s efforts to lower rates, has raised alarms among market participants.
Analysts point to several factors contributing to this trend. Long-term inflationary expectations are a primary concern. Although consumer inflation was recorded at a multi-year low of 1.6% in July, market players anticipate an uptick in inflation in the near future. Sandeep Bagla, CEO of Trust Mutual Fund, noted that while current inflation figures are low, the expectation of future inflation remains high. This sentiment is reflected in the bond market, where investors are seeking protection against potential inflationary pressures.
Impact of RBI’s Policy Changes
The RBI has cut its policy rates by a total of 100 basis points since February, aiming to boost economic growth. However, the anticipated benefits of these cuts have not materialized in the form of lower loan rates for consumers. The central bank’s recent projections indicate that consumer inflation for the fiscal year 2026 is expected to rise to 3.1%, reaching 4.9% by the first quarter of fiscal year 2027. This outlook has further complicated the bond market’s response to monetary policy changes.
The relationship between bond yields and interest rates is complex. Typically, when the central bank lowers rates, bond prices rise, leading to lower yields. However, the current situation reflects a “notable dislocation,” as described by Devang Shah, head of fixed income at Axis Mutual Fund. He attributes this divergence to structural imbalances and evolving fiscal expectations, which have created uncertainty in the market.
Concerns Over Government Revenue
Another layer of complexity arises from concerns about potential revenue losses for both central and state governments due to expected cuts in Goods and Services Tax (GST) rates. Market players are questioning whether governments will resort to increased borrowing to compensate for these losses. This uncertainty could further influence bond yields and the overall economic landscape.
As the RBI continues to navigate these challenges, the effectiveness of its monetary policy remains under scrutiny. The central bank’s ability to manage inflation expectations while supporting economic growth will be crucial in the coming months. The current dynamics in the bond market serve as a reminder of the intricate balance required in economic policymaking, where multiple factors can influence outcomes in unexpected ways.
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