Determinants of Yields on Government Securities in India

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This article examines the determinants of government yields in India using weekly data from April 2001 through June 2012. The analysis covers treasury bills with residual maturity of 15–91 days and government securities of residual maturity 1, 5 and 10 years. The empirical estimates show that a long-run relationship exists between each of these interest rates and the policy rate, rate of growth of money supply, inflation, interest rate spread, foreign interest rate and forward premium. At the same time, the empirical results show that the relative importance of the determinants varies across the maturity spectrum. The normalised generalised variance decompositions suggest that the policy rate and the rate of growth of high-powered money are more important in explaining the proportion of variation in shorter-term interest rates than the longer-term rates. The weight of the forward premium also diminishes as we move towards higher maturity interest rates. The inflation rate becomes relatively less important in explaining variations in the yields as the maturity of the security increases. The yield spread, on the other hand, is more important in explaining the longer-term rates. The results also show that a large proportion of the variation in the rates on the 5-year and 10-year government securities is attributed to the interest rate itself, suggesting that the unexplained variation may be a result of cyclical factors that are relatively more important for longer-term rates but are not captured by the yield spread and are omitted from the estimations in this article due to the high frequency of data employed here.