Relevance: GS III (Indian Economy – Fiscal & Monetary Policy) | Source: Indian Express
1. The Economic Anomaly
Normally, when the Reserve Bank of India (RBI) cuts the Repo Rate (the rate at which it lends to banks), borrowing becomes cheaper for everyone, including the government.
- The Anomaly: Since February 2025, the RBI has cut the Repo Rate significantly by 125 basis points (from 6.5% to 5.25%).
- The Reality: Instead of falling, the interest rates (yields) on government bonds have risen. The benchmark 10-year G-Sec yield has climbed from 6.66% to 6.73%, meaning the government is paying more interest to borrow money.
2. Why is this happening? (The Drivers)
The failure of “Monetary Transmission” (rate cuts not reaching the market) is driven by two factors:
A. Structural: The Debt Mountain
- Oversupply of Bonds: The government is borrowing heavily to fund its deficit. When the supply of bonds increases in the market, their price falls, and their yield (interest rate) rises.
- Debt Data:
- Centre’s Debt-to-GDP: Currently ~54.7% (Far above the FRBM target of 40%).
- Interest Burden: The Centre spends nearly 38.1% of its total revenue just on paying interest.
B. Cyclical: The Liquidity Crunch
- Foreign Outflows: Foreign investors (FPIs) are pulling money out of India ($18.9 billion outflow).
- RBI’s Action: To prevent the Rupee from crashing due to these outflows, the RBI is selling dollars.
- The Squeeze: When RBI sells dollars, it sucks Rupees out of the banking system. This creates a shortage of cash (liquidity). When money is scarce, its price (interest rate) goes up, cancelling out the benefit of the Repo Rate cut.
UPSC Value Box
| Concept / Act | Relevance for Prelims |
| Bond Yield | The effective rate of return an investor gets on a bond. It has an Inverse Relationship with bond prices. If bond prices fall (due to high supply/selling), yields rise. |
| Crowding Out | A phenomenon where excessive government borrowing soaks up all available banking liquidity, leaving little money for the private sector and pushing up interest rates for them. |
| FRBM Act (2018 Targets) | The Fiscal Responsibility and Budget Management Act set a target Debt-to-GDP ratio of 60% for the General Government (40% Centre + 20% States) by 2024-25. India is currently missing this target. |
Q. With reference to the Indian economy, consider the following statements regarding Government Security (G-Sec) Yields:
- If the Reserve Bank of India conducts Open Market Operations (OMO) by selling government securities, the bond yields are likely to increase.
- A rise in the fiscal deficit of the government generally leads to a decrease in bond yields.
- Bond yields and bond prices generally move in opposite directions.
Which of the statements given above is/are correct?
(a) 1 only
(b) 1 and 3 only
(c) 2 and 3 only
(d) 1, 2 and 3
Correct Answer: (b)
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