Government securities yield curve points to improving long-term economic outlook: RBI article

Movements in the government securities yield curve (g-sec) signal an improvement in the country’s long-term economic prospects, a paper authored by RBI staffers, including Vice Governor Michael Patra, said on Thursday.

The paper said the g-sec yield curve contains important clues about the likely behavior of the economy.

It can be noted that over the past two years, policy efforts have been focused on helping the economy recover from the setbacks of the pandemic, but the surge in inflation has led the RBI to shift its focus to taming price increases. by raising rates.

These increases have led many to believe that efforts to contain inflation will come at a cost by denting growth prospects. GDP grew 8.7 percent in FY22, after contracting 6.6 percent in FY21, and the RBI estimates it will grow 7.2 percent in FY23.

“The yield curve points to an improvement in the long-term growth outlook and an upward shift in ex-ante inflation expectations,” Patra, head of the central bank’s central monetary policy function, wrote in the article published in the monthly bulletin.

The yield curve has become steeper and concave, it said, adding that this confirms expectations of tighter monetary policy in the coming period.

The article, which does not reflect an institutional view, said the yield curve slope steepened with the onset of pandemic-related policy easing, which has been reversed in the recent phase of policy tightening, where the RBI has cut interest rates by 0.90 percent in two runs. increased. actions since May 4.

It explained that the yield curve level and curve, not the slope, contains useful information about market expectations about economic prospects and inflation expectations.

“…The yield curve is concave compared to 2019 levels, pointing to a stronger recovery outlook, higher inflation expectations and thus market expectations of a frontal normalization of monetary policy,” it said.

The curvature increased sharply during the pandemic-related easing and after the Union budget’s announcement of a major market lending program for 2021-22 until the announcement of G-SAP in April 2021, it said.

As for the level, it said the yield curve level has risen since 2021 after a steep decline during the pandemic, it said.

The paper uses a state space yield macro model to show that, unlike advanced economies, yield curve level and curve rather than slope provide useful information about market expectations about economic prospects and inflation expectations, the article said. .

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