Factors causing movements of yield curve in India

a r t i c l e i n f o Keywords: Estimation of term structure of interest rate Financial reforms Latent factor extraction Level Monetary policy Yield curve movements The article identifies principal reasons underlying the movements of yield curve for government debt market in India for the period Jul '97 to Dec '11. The study finds that though statistically Svensson's (SV) (1994) model outperforms Nelson and Siegel's (NS) (1987) model in yield curve estimation, 99% of the movements in yield curves in India are explained by three factors which are 'level' (long-term factor), 'Slope' (short-term factor) and 'Curvature' (medium-term factor) with 'level' contributing more than 90% of its variations. This implies that in more than 90% of cases, the yield curves move parallel either in upward or in downward direction bringing similar effects to all maturity spectrums. This means that yield curve movements in India mainly reflect the monetary policy changes of central bank. Hence, NS's three parameter model is probably more than sufficient to capture all possible shapes of yield curves in India. This finding also suggests that a simple 'duration and convexity' hedging strategy should be appropriate to cover maximum risk exposure of government debt market investors in India. The Indian debt markets are relatively less developed compared to its equity markets. Government debt market is mostly restricted to the trading in government securities only. Bonds and other fixed income instruments issued by the public sector units, financial institutions and corporate are the main trading instruments in the non-government (NG) debt market. Government debt market in India has developed much faster over the course of time in terms of liquidity, transparency and volume of transactions as compared to NG debt market after the deregulation of financial markets since 1991. As of 2005, about 91% of all debt securities accounts to the government, 7–8% to financial institutions, and less than 2% to corporate debt. The government debt market stands at 25% of GDP while the corporate debt to GDP is 5% as of 2009. The total market loans of central government securities in 2003 was Rs 6.8 billion as opposed to Rs 1.4 billion in 1996. The outstanding loan for 2009 was Rs 13.6 billion. The estimation of term structure of interest rates or a benchmark zero coupon yield curve for government debt market has been possible after the liberalisation of the Indian financial market. In the …