Why have bond yields rallied so sharply in India and what does that indicate?

Over the last one year, bond yields on the 10-year benchmark are up from 6% to 7.518% with nearly half of this rally coming just in the last two months. There are several triggers. Firstly, RBI has also shown hawkishness in policy like the Fed and it plans to raise the repo rates very fast. It has hiked rates by 40 bps in May 2022 and by another 50 bps in June 2022, taking total repo rates to 4.90%. That spiked bond yields. Secondly, the CPI inflation at 7.79% and WPI inflation at 15.08% have also been the reasons for the rise in yields.

The total borrowings of the government are an important factor in rising yields. Here is the story. For FY23, the borrowing target stands at a record Rs14.31 trillion. Now, to fight inflation with monetary and fiscal measures, the government has raised it by another Rs1 trillion. The government has also hinted at full year fiscal deficit slipping from 6.4% to 6.9%. Both these factors have resulted in a spike in the 10 year bond yields as more borrowings would create pressure on the yields and hit the corporate borrowers the most.

What could this mean? Firstly, it increases the cost of borrowing for Indian corporates and more specifically the mid-cap and the small cap companies. The other outcome is that for the companies with high leverage and low coverage, spike in bond yields raises solvency risk. Valuations normally take a hit amidst rising yields due to higher cost of capital. Future cash flows tend to get valued at lower current values due to higher debt cost. Government also faces the risk of more devolvement on the RBI of bond issues.