What upset this balance in the markets?
First, demand and supply. The government has been a heavy borrower – for good reason – since the Covid-19 crisis hit. As revenue came under pressure and expenditure soared, the government borrowed over Rs 12.8 lakh crore in FY21, Rs 12 lakh crore in FY22 and is expected to borrow a similar amount next year.
That’s a lot of government bonds to sell. Buyers of these bonds – banks, insurers, pension funds – have already bought many of these securities and demand is dwindling.
Supply > Ask = Lower price. Lowering the price of the bond, increasing the yield, which moves in the opposite direction. That pushed the spread between the overnight policy rate, at which banks borrow from the central bank, and the yield on benchmark 10-year government bonds to a record high of more than 250 basis points.
In short, the government must pay more interest to borrow for the long term.
However, this does not fully explain the current situation.
The deluge of liquidity in the system is another culprit of rate bias. The central bank flooded the system with cash after the hit of the Covid crisis, but demand for loans is still modest, even if it is increasing. Deposit growth, on the other hand, remained strong.
Banks therefore struggled to find ways to park their cash and most flocked to home loans. This, as BloombergQuint reported earlier, leads to a misjudgment of risk. For lenders, home loans continue to provide a safe place to anchor their cash. These loans, unlike many other categories of personal credit, are secured and have some of the lowest default rates. So even though lenders are making smaller margins here, they are reassured that defaults will be lower.
This has driven home loan rates to multi-year lows.