Category Archives: Economy

Yield Curve Analysis of Indian Economy Since 2000

Over the past few weeks, the economy of India has been in focus because of various factors such as decline in INR, slowdown in industrial production, etc. We keep reading a lot of articles that suggest that the policies of current government are responsible for this state of affairs. However, most of these articles don’t have sufficient data or charts to support the same. This is an attempt to map macroeconomic data with the articles.

First of all, it needs to be understood that destruction of a solid foundation takes some time even for the worst policies. No wonder, the first few years of UPA government, i.e. from 2004-2008, didn’t show any bad effect on the economy. However, it was the post-crisis period that really showed what the government’s intent was.

I have already written in previous posts how certain policies have adversely impacted Indian economy in the last few years. This time around, I use the yield curves and the 10 year treasury yield to indicate the same.

Typical shape of the yield curve

A typical yield curve should be upward sloping indicating that the higher returns/rates/yields should be provided for taking higher risks which are generally over the long term. Similarly, lower returns/rates/yields should be for lower risks which are generally short term. In short, longer the time frame, higher should be the rate/yield that you should earn. Hence, a typical yield curve would look something like this.


For more details on yield curve, there are several articles that you can search on the net

There are several types of yield curve depending on the interest rate expectations in an economy as listed below –

1. Normal yield curve – his positive slope reflects investor expectations for the economy to grow in the future and, importantly, for this growth to be associated with a greater expectation that inflation will rise in the future rather than fall. For details, refer here

2. Steep yield curve – when the gap between the longer term maturities and 1-3 month maturities increases beyond the long term average, the economy is expected to improve quickly in the future. This type of curve can be seen at the beginning of an economic expansion (or after the end of a recession).

3. Flat or humped yield curve – all maturities have similar yields, whereas a humped curve results when short-term and long-term yields are equal and medium-term yields are higher than those of the short-term and long-term. A flat curve sends signals of uncertainty in the economy. This mixed signal can revert to a normal curve or could later result into an inverted curve.

4. Inverted yield curve – long-term yields fall below short-term yields. Long-term investors settle for lower yields now if they think the economy will slow or even decline in the future. An inverted curve has indicated a worsening economic situation in the future 6 out of 7 times since 1970.

As can be seen above, our present yield curve indicates a flat to inverted yield cuve. The gap between 10 year and 1 year yield is negative 10 bps whereas between 30 year and 1 year yield is only 30 bps. This indicates that there are no investors who are ready to take a call on the long term prospects of the economy. Rather, they would prefer to invest in the 1 year maturity which provides the same returns as a 10 year or 30 year government paper.


While the above is the complete yield curve, investors and economists are more interested in some popular yields such as the 3M (91 day), 1 year, and 10 year. Hence, another way to describe the yield curve is to check the spread between the 10 year and 1 year yields over a period of time. If the spreads increase over a period of time in positive territory or remain in positive territory on a consistent basis, it means that economy is either improving, getting stronger, or expected to boom in coming years. In contrast, if the spread is negative or close to zero or is in a tight band for a prolonged period, then it means that economy is in slowdown or either going into a recession or into stagflation.


Another way to look at is the movement of the 10 year treasury yield over a long time frame. As the chart below shows, during the NDA regime, 10 year treasury yields fell from a high of 10-12% in 1998-99 to ~ 5% in 2004. While it can be argued that downward yield movement was in response to economic slowdown, the spreads in 2004 indicate that the economy was on the verge of strong sustained growth in future years. This was also evident from the strong growth in GDP in the years from 2004-2008 as well as decent GDP growth rate during the NDA regime.



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In contrast, since UPA government came into power, spreads between yields have tended to compress. Note that the sharp jump in spread around 2008-09 was due to the global economic crisis which required massive stimulus and led to short term economic recovery. Otherwise, at various periods such as from March 2005 to Feb 2008 and after March 2010, spreads have tended towards 0 or negative territory.


One more related point is the inflation levels. While yields fell during NDA, it was marked by stable low inflation of ~ 4% throughout. In contrast, UPA has been marked by persistently high inflation with CPI hovering ~ 10%. This has been most prominent in last 2-3 years when high inflation coupled with slow economic growth and falling spread between 10Y and 1Y yields indicate persistent economic slowdown or recession. 



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Other major economies to struggle

Historically, improvement in US economy has translated to economic growth in rest of the world with a slight lag. However, this time, the major economies like Europe, Japan, China and other emerging markets (EM) are expected to remain weak with low growth owing to various issues. This was because unlike the US, they undertook monetary easing without controlling their fiscal deficit.

For instance, Europe is grappling with the existence of Euro itself and reducing the high fiscal deficit in the unproductive high-cost Southern European economies like Spain, Italy, Greece, etc. The crisis is gradually engulfing even France and other Northern European economies. There are no easy solutions to the crisis as the past 2 years have shown where despite ECB’s best efforts, GDP growth among all member economies have floundered. Only Germany stands apart in European Union with its dominance in manufacture of high-end engineering goods and exports to emerging markets across the world. The unemployment rate has been shot up in recent years as well. Since most of the other developed and emerging market economies are expected to struggle, their currencies will depreciate against USD. Since Germany will struggle due to its focus on EM, EUR will also depreciate against USD.

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Japan has been in a deflationary scenario for almost 2 decades and the effects of Abenomics have already reversed their effect to a major extent. Japan has already undertaken a monetary easing similar to that of US. However, it has adopted active JPY depreciation to battle the deflation since it doesn’t have a solid domestic growth story like that of US. The impact of Abenomics is yet to be seen and its effects will be seen in 2015-16 at the earliest.


China wants to grow at its historical growth rate but is now reeling under the adverse effects of past monetary and fiscal stimulus which has led to high borrowing costs in the shadow banking system. Hence, China has no ammunition left for further stimulus. In case China grows at lower growth rate, it will have a negative spillover effect on rest of Asia and commodity dependent economies like Australia, Brazil, etc.

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US economy in Strengthening Mode Since 2011

The 2008 global financial crisis resulted in US Fed reducing its interest rates and indulging in a series of Quantitative Easing (QE) to ease the volatility and fall in capital markets across the world. It was aided by other central banks such as ECB, BoE, etc. to inject a massive USD 12 trillion into the world economy, almost 1/6th of global economic GDP.

The process was aimed at inflating asset prices across categories such as equities and real estate. Through this, as asset prices begin to improve, the holders of those assets would experience a positive wealth effect which in turn would improve spending and consumption. The initial measures helped avoid the deep depression like situation of the 1930s. But US GDP failed to grow after that and it necessitated further measures from US Fed such as QE2 and QE3 in addition to other stimulus components.

Eventually, measures have started to positively impact US GDP as the recent readings of US economic indicators show.


The US housing has made a strong comeback in terms of permits and starts.


The US equity markets have also become stronger on the back of strong balance sheets of US companies and improving earnings profile. Both DJIA (1st chart) and S&P 500 (2nd chart) have shown gradual improvement since the crisis.


US economy till now was mainly dependent on foreign oil. Discovery and commercialization of shale gas deposits across US have reduced this dependence and are expected to become a larger portion of total crude requirements in future. This automatically reduces the wasteful defence expenditure on Middle East. This is already evident from the lower direct involvement in recent ME problems such as Syria, Arab Spring, etc.

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In addition, US doesn’t have a strong rail road network like that of India or China. It has been traditionally dependent on roads for transportation of goods and people. US government is planning big infrastructure projects such as new railroads to connect various towns and cities. The Passenger Rail Investment and Improvement Act (PRIIA), 2008 plans to spend USD 200 bn in upgradation of existing rail network and new rail lines including the High-Speed Intercity Passenger Rail (HSIPR) program.

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Also, gas infrastructure pipelines to transport the shale gas and ports for possible export of surplus gas have been developed in last few years. Many more of such projects are in pipeline.


Large infrastructure projects help generate a variety of jobs. This coupled with Recovery Act, 2009 and several other job creation initiatives has resulted in steady addition to the US non-farm payroll additions since the recession. It is nearing pre-crisis levels. US unemployment rate is expected to reduce from current levels going forward. Once employment indicators improve, the US consumer becomes more confident of his future and hence starts leveraging.


Reduced crude and natural gas imports coupled with focus on domestic economy and consumption also help bring fiscal deficit under control and which becomes supportive of long term US GDP growth.

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The massive Fed actions over the past few years resulted in suppressed bond yields for a long time. However, recent positive indicators coupled with low inflation levels have resulted in real positive interest rates which are reflected in improvement in US Treasuries. For instance, US 10 year treasury yield has increased to ~ 2.6%, an increase of ~ 45% in the last 1 month itself. The upward movement in yield curves over past 6 months is reflected in the chart below


Hence US GDP is expected to grow from here on at a reasonable rate of ~ 3% over the next 5 years. For such a large economy, GDP growth at ~ 3% results in employment generation in several of these new growth areas and sufficient to maintain low inflation levels.

Since US economy is on a rise and unemployment numbers are expected to come down, US Fed has taken the correct step of tapering the QE and eventually winding it down. While Fed hasn’t decided on the exact timing of tapering, the very mention of that word indicates its intent. Hence, the easy money and liquidity that was floating in the world economy will go away. While Fed balance sheet shrinkage does cause temporary fall in the equity markets, it eventually begins to improve again as shown in the chart below. With the eventual rise in GDP, US equity markets will become stronger.


The period from 2013-18 could be similar to 1995-2000 when US economy improved significantly beating all expectations of the time. During 1995-2000, significant investments and advancements in semiconductor industry resulted in growth opportunities for IT, communications, biosciences, and other IT-using industries. The cheaper IT prices reduced costs and improved performances across sectors such as automobiles, aircraft, scientific instruments, retail, banking, etc.



Consequently, USD strengthened by ~ 38% against INR in this period. Even against other currencies like JPY and GBP, it was strong for most part of the period – at one point, USD appreciated by ~ 85% against JPY and ~ 15% against GBP. A similar period of productivity led growth is expected in the US in the next several years. This coupled with improvement in yields and equity markets will lead to USD strengthening from current levels. Some of it has already happened in recent months as shown in the chart below.



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Basic Relations between Equity, Debt and Currency markets

The bond, equity and currency markets of an economy move based on fiscal (GDP growth, fiscal deficit, CAD, etc.) and monetary policies (inflation, interest rates, etc.) in addition to global liquidity scenario and prevailing policies in other major economies. At a broad level, the following table holds true.


GDP Growth rate

Inflation rate

Yield rate Moves

Equity Indices Move


























A slump in economic growth can be tackled through 3 major avenues –

1. Fiscal policy – through a fiscal expansion (government spending)

2. Monetary policy – cutting benchmark interest rates, improving domestic liquidity in banking system

3. Currency – increasing exports and cutting back on imports

A big currency movement happens when transition occurs from one quadrant to another. Currency movement depends on the fiscal and monetary policies of the country. In case of contractionary fiscal policy and accommodative monetary policy, exchange rate will tend to be weak.

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