Shrinking yield gap prompts shift in Indian bond market dynamics
The difference between the yield of Indian and American treasury bonds has reached its lowest level in two decades, which may lead to capital outflow from the Indian debt market, according to calculations by Bloomberg agency.
The yield on Indian bonds is steadily decreasing, driven by the country's strong fiscal position, declining inflation, and expectations of interest rate cuts, according to DBS Bank Ltd. This trend contrasts with the situation in the United States, where recent tax cuts passed on Thursday have raised concerns about the level of debt. The contrast is so significant that billionaire and banker Uday Kotak wonders if the yield on Indian bonds could ultimately fall below those of American bonds.
"This compression is likely to hold given a favourable change in India’s rates backdrop at this juncture, while investors’ worries over US’ fiscal strains are still to be addressed," wrote Radhika Rao, senior economist at DBS Bank, in a note.
Capital inflow despite decreasing yield advantage
Foreign investors have injected a net $2.3 (€2) billion into Indian rupee-denominated debt this year, although the current quarter saw an outflow of about $4 (€3.5) billion. While a shrinking yield advantage is usually negative for emerging markets, India's strong macroeconomic fundamentals may continue to provide some capital inflow, traders say.
"Though the narrowing spread normally reduce the fund flow to Indian market, this time with sound fiscal position and less riskier currency dynamics we may still get flows in debt market," said Gopal Tripathi, head of treasury and capital markets at Jana Small Finance Bank.
Indian bonds are becoming increasingly integrated with global markets following the inclusion of local treasury bonds into key emerging market indices, including those managed by JPMorgan Chase & Co. The yield on 10-year Indian bonds is currently 6.20% annually, while American bonds yield 4.60%, resulting in a difference of 1.60%.
Outlook for the Indian bond market
Billionaire Uday Kotak is contemplating whether, in the future, the yield on Indian bonds may fall below those of American bonds. According to him, it mainly depends on relative inflation, risk premium, confidence, and liquidity for global and domestic investors in both countries. This comment came as the difference in yields reached the lowest point in his memory.
Indian treasury bonds are also gaining attractiveness due to the country's strong fiscal position. The Reserve Bank of India (RBI), under the leadership of the new Governor Sanjay Malhotra, recently made the first rate cut since 2020, which led to an increase in the prices of short-term Indian bonds.
Analysts point out that although the growth rate of loans in Indian banks is the slowest since 2022, tycoon Birla achieved the cheapest issuance of rupee-denominated bonds in five years. This indicates growing confidence in the Indian debt market, despite the shrinking spread compared to American securities.
