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MOSL: ECOSCOPE-What explains high premium on sovereign bonds and why it may remain elevated

ECOSCOPE: What explains high premium on sovereign bonds and why it may remain elevated

 

• As against an average premium of ~45bp in the 4-year period (FY12-15), the spread between the benchmark 10-year government bond yield and the policy repo rate has doubled to ~90bp in the past four years (FY16-19), and was at an 8-year high of 1.39pp in FY19. In fact, the premium on the benchmark bond yield has not fallen below 90bp in any of the past 18 months and was ~1.5pp in the first two months of FY20 (before falling to 1.1bp this week).
• This high premium, we believe, is a result of a combination of (a) weak domestic financial funds (not equivalent to financial savings), and (b) high public sector (including central government, state governments and CPSEs) deficit. India’s public sector absorbed more than 70% of domestic financial funds in the past four years (FY16-19) v/s ~60% in the previous five years (FY11-15). The ratio is estimated at 75% in FY19, thrice its trough of only ~25% in FY08.