Analysing the determinants of 10-year government bond yield in Sri Lanka

Abstract

Introduction: This study investigates the determinants of the 10-year government bond yield in Sri Lanka over the period 2015–2024, aiming to understand the short-run and long-run dynamics between macroeconomic and financial variables and long-term government securities. Utilizing monthly data on inflation (CCPI), exchange rate (USDLKR), bank rate (BR), industrial production (IIP), stock market performance (ASPI), and budget balance (BB), the study applies unit root tests, Johansen cointegration, Granger causality tests, and a Vector Error Correction Model (VECM) to examine the relationships.

Empirical results indicate that, in the short run, inflation, exchange rate, and budget balance have a significant positive effect on bond yields, while stock market performance exerts a significant negative effect, and the bank rate shows a slight negative effect. Industrial production does not exhibit any significant short-run impact. In the long run, exchange rate and budget balance maintain a positive relationship with bond yield, while the bank rate has a significant negative effect. Other variables, including inflation, industrial production, and stock market performance, do not show significant long-term effects. The model explains approximately 74% of short-term variations in bond yields. Granger causality analysis reveals bidirectional causality between bond yields and inflation, exchange rate, and stock market indices.

The study underscores the importance of understanding macroeconomic and financial drivers of long-term government securities for both policymakers and investors. Insights from this research can guide monetary and fiscal strategies, debt management, and investment decision-making in Sri Lanka’s government bond market.