Should a benchmark bond yield guide RBI's repo rate decisions?

A broadly steady 10-year G-Sec yield could be taken as a cue if it reflects an efficient market at work

- MADAN SABNAVIS

The 10-year government bond yield is a benchmark that determines the interest-rate environment in the debt market.

While there are several bonds traded in India, this bond attracts the most attention. Since June, its yield has stubbornly stayed in a 6.40-6.60% range. This is notwithstanding the fact that the Reserve Bank of India (RBI) has been lowering its repo rate, which ought to have pulled down bond yields.

This divergence would not be an issue if it did not affect interest rates beyond the market for government securities (G-Secs), such as the rates of bonds issued by state governments and corporations. But all bond yields are benchmarked with what G-Secs offer. Hence, depending on the spread that must be offered above G-Sec rates (as a risk premium), they need to be priced accordingly. States lament that their cost of borrowing has gone up. Corporates too have to pay higher rates, even as bank loans have gotten cheaper.

We face an anomalous situation. Banks perforce have to lower lending rates when the repo rate is lowered, as several of their loans are directly linked with repo movements. The system of external benchmark lending rate (EBLR) is unique to India, mandating that some loans be tied to an external benchmark. Hence, when the repo rate falls, so does the lending rate. The idea is to ensure swift policy transmission.