Abstract
This paper investigates the long-term determinants of Indian government bonds’ (IGB) nominal yields. It examines whether John Maynard Keynes’s supposition that short-term interest rates are the key driver of long-term government bond yields holds over the long-run horizon, after controlling for various key economic factors such as inflationary pressure and measures of economic activity. It also appraises whether the government finance variable — the ratio of government debt to nominal income — has an adverse effect on government bond yields over a long-run horizon. The models estimated here show that in India, short-term interest rates are the key driver of long-term government bond yields over the long run. However, the ratio of government debt and nominal income does not have any discernible adverse effect on yields over a long-run horizon. These findings will help policymakers in India (and elsewhere) to use information on the current trend in short-term interest rates, the federal fiscal balance, and other key macro variables to form their long-term outlook on IGB yields, and to understand the implications of the government’s fiscal stance on the government bond market.
Highlights
This paper examines whether Keynes’s conjecture that short-term interest rates are the key driver of long-term government bond yields holds in India over the long term after controlling for various key economic factors, such as inflationary pressure and measures of economic activity
It appraises if public finance variables, such as the ratio of government debt to nominal income, have an adverse effect on government bond yields in India
Akram and Das (2015a and 2105b) report that Keynes’s conjectures hold in India for the short-run horizon. They find that government finance variables do not appear to exert upward pressure on Indian government bond yields
Summary
John Maynard Keynes (1930) contends that a central bank’s monetary policy is the most important driver of long-term interest rates. The section introduces the behavioral equations, time-series data, and econometric methods to be used in examining the importance of short-term interest rates, government finance variables, and other key macroeconomic variables in determining the nominal yields on Indian government bonds over the long-run horizon. Equation [2.7] equation [2.8] equation [2.9] equation [2.10] equation [2.11] equation [2.12] These equations are estimated using quarterly data for bond yields of government securities for various tenors with short-term interest rates, the rate of inflation, the growth rate, and the government finance variable as explanatory variables. The null hypothesis of no cointegration is rejected whenever the F-statistics value is higher than the upper bounds value This analysis confirms the presence of a long-run relationship among long-term government bond yields, short-term interest rates, the rate of inflation, and the growth in industrial production. Upper bounds values are 6.36, 5.52, and 4.14 for 1 percent, 5 percent, and 10 percent levels of significance, respectively
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