Movements on the government securities (g-sec) yield curve are indicating an improvement in the long-term economic prospects of the country, a paper written by RBI staffers including Deputy Governor Michael Patra, said on Thursday.
The paper said the g-sec yield curve contains important clues on the likely behaviour of the economy.
It can be noted that for over the last two years, policy efforts have been concentrated on helping the economy recover from the reverses of the pandemic, but the surge in inflation has led the RBI to shift focus to taming price rise by increasing rates.
These hikes have led many to believe that the efforts to control inflation will extract a cost by denting growth prospects. The GDP expanded 8.7 per cent in FY22 after 6.6 per cent contraction in FY21, and is estimated by RBI to expand by 7.2 per cent in FY23.
“The yield curve is indicating an improvement in long-term growth prospects and an upshift in ex ante inflation expectations,” Patra, who heads the crucial monetary policy function in the central bank, wrote in the article published in the monthly bulletin.
The yield curve has become steeper and concave, it said, adding that this reconfirms expectations of tighter monetary policy in the period ahead.
The article, which does not represent institutional view, said the slope of the yield curve steepened with the onset of pandemic-related policy easing, which has reversed in the recent policy tightening phase, where the RBI has hiked rates by 0.90 per cent in two actions since May 4.
It explained that it is the level and curvature of the yield curve, rather than its slope, that contain useful information on market expectations about economic prospects and inflation expectations.
“… The yield curve is concave compared to 2019 levels, indicative of strengthening prospects for the recovery, higher inflation expectations and hence market expectations of front-loaded monetary policy normalisation,” it said.
The curvature increased sharply during the pandemic-related easing and after the Union Budget announcement of a large market borrowing programme for 2021-22 till the announcement of G-SAP in April 2021, it said.
As regards the level, it said the level of the yield curve has increased since 2021 after a steep decline during the pandemic, it said.
The article uses a state space yield-macro model to show that in contrast to advanced economies, it is the level and curvature of the yield curve rather than its slope that contain useful information on market expectations about economic prospects and inflation expectations, it said.