The 10 Year zero coupon Government bond yields have fallen by 22 bps since March 2017 and by 54 bps since March 2016. We are seeing somewhat stable bond yields across all tenures since demonetization where we saw a large dip in the government bond yields falling up to 149 bps during that period. The discount rates have been very volatile during the last 4 quarters. Due to demonetization the zero coupon bonds saw decrease in yields during Sep 16 to Dec 16 followed by increase in the next Quarter ending March 2017.
The lower and stable bond yields bring stability in the economy; however consistently reducing bond yields has an adverse impact on the financials of the companies especially where the employee benefits liabilities are concerned.
We can see from both the Graph as well as the table above that the zero coupons Government bond yields as on 30th June 2017 except for tenures 1 and 2 have fallen over 4 bps to 26 bps when compared to the yields as on 31st March 2017. There is a small increase in the yields for tenures 1 and 2.
When comparing the June 2017 government bond yields with the March 2016 Yields, we can see a significant drop in yields ranging from 54bps to 105 bps.
The discount rate has an inverse correlation with the value of the liability, i.e. a lower discount rate results in a higher defined benefit obligation and vice versa, so for most companies, an increased discount rate in March 2017 would have given some release in liability , the trend being reversed in June 2017.
Fall in the Bond Yields has a direct impact on the balance sheet and the P&L of the organizations, as In India, the defined benefit obligations are determined with reference to the market yields at the balance sheet date on government bonds of appropriate tenure according to the Para 78 of the AS 15 (Revised 2005) and Para 83 of the Indian Accounting Standard (Ind AS) 19. Also, the currency and term of the government bonds need to be consistent with the currency and estimated term of the post-employment benefit obligations.”
While the total Employee benefit obligation depends on many factors, the impact of reduction by 50 bps in the discount rate is anywhere in between 0.83% to 8.28% depending on the Future working life time/Duration of the liabilities on which the Discount rate depends.
Assuming an Average future working life time of 10 years, the impact of the decrease in bond rates as on 30th June 2017 may result in the liabilities to increase approximately by 2.5% since March 2017 and by 5% since March 2016 which for organizations with large liabilities is quite a big impact to the financials.
Will GST have any impact on Government bond Yields?
While the Goods and Services Tax (GST) is not directly related to Government bond Yields, the impact of GST over state finances may push up the yields on state bonds which in turn can increase the yields slightly. Mostly the market will remain in wait and watch mode for some time and overall the yields are expected to remain narrow range bound for couple of quarters.
The above article does not provide any legal/statutory advice and should only be used for general reference only.
The author of this note is Chitra Jayasimha, Actuary and Practice Leader, RFM at Aon Hewitt Consulting, India. She may be contacted at Chitra.firstname.lastname@example.org or at +91-9987769877.