The period since the beginning of 2023 has been marked by growing uncertainty. Even as all nations struggled with stubborn inflation and slowing growth, continuation of the Russia-Ukraine conflict, breakout of Israel-Palestine war last October and elections in two of the most populous democracies have heightened the risks. But amidst this bedlam, Indian government bonds have been in a zen mode; with the 10-year bond trudging nonchalantly in a small range of 7-7.4 per cent.
This behaviour is in contrast with other sovereign bonds which have been swinging wildly over the last two years. Indian government securities (G-secs), on the other hand, seem to have been insulated from the volatility in global markets in this period.
This was corroborated by a businessline analysis of the correlation between the 10-year US treasury securities and 10-year sovereign bonds of India, China, Brazil, Indonesia and South Korea. It was found that the link between Indian and US bonds weakened considerably in the period between January 2023 and April 2024 even as other emerging market bonds continued to move in step with the US treasury securities yield.
Why is India on a different plane when compared with other emerging economies? Numerous factors seem to be contributing including declining government borrowing, increasing demand due to the global bond index inclusion and a stable rupee. This resilience provides room for the RBI to follow a monetary policy independent of the Fed and other central banks.
Rate hike cycle
Indian 10-year government bond yield had hit a low of 5.7 per cent following the Covid onset in July 2020. Yields began inching up from those levels in 2021, caused by massive FPI selling of Indian G-secs in 2020-21. But yields began hardening sharply from 2022, following rate hikes by the Fed and RBI, and rising US treasury yields. By June 2022, Indian bond yields had risen to 7.45 per cent. But they have not surpassed that level in the following 22 months, moving in the 7-7.4 per cent range.
US 10-year bond yields too began rising sharply from 2022 when the Fed began its aggressive rate hikes; 10-year yields shot up to 3.8 per cent that year, marking a 13-year high. The commencement of the Russia-Ukraine war in February 2022 further added to the volatility.
But US yields have continued to move higher in 2023 too, moving close to the 5 per cent mark in October 2023, when the Hamas attacked Israel. Yields have been volatile since then as bond market first anticipated sharp rate cuts in 2024 and sent bond prices higher. As Fed doused those hopes, bond prices have sold off, pushing yields to 4.6 per cent level again.
Of interest is that sovereign bonds of other emerging economies such as Brazil, Indonesia and South Korea have mimicked the movement of the US treasuries since 2023, rising and falling with it, in contrast with Indian bond yield movement.
Weakening correlation
Typically, the US treasury yield plays pied piper to the yields of sovereign bonds of emerging markets. The reasons behind this link is simple. As bond yields in the US increase, they become more attractive when compared with other sovereign bonds. This makes institutional investors based in the US sell the sovereign bonds of emerging markets and invest in US treasuries. This leads to sell-off in government bonds of emerging economies, pushing their yields higher. The converse takes place when US treasury yields decline.
Indian G-sec yield too closely followed the US treasury yields in the period before 2023. The correlation coefficient (which shows the strength in the relationship between two variables, and ranges between -1 and 1) between 10-year US treasury bond yield and 10-year Indian government bond yield for the period January 2019 to December 2022 was quite high, at 0.90. This indicates a very strong linkage.
But the correlation has weakened to 0.15 for the period January 2023 to April 2024. This means that Indian bonds are not following the US treasuries closely any more, though the direction of moves is similar.
A similar analysis on the link between 10-year US treasury bonds and 10-year bonds of Indonesia, Brazil, China and South Korea showed that the correlations remained strong, above 0.78 in the period January 2023 to April 2024.
In other words, only Indian government bonds appear to be disassociating from their US peers.
Many boosters
Why are Indian sovereign bond yields displaying resilience?
The fundamental strength to Indian government bonds came from the fiscal prudence of the government, which resulted in keeping government debt under check. According to the IMF, government debt to GDP ratio of India is 77.55 while the ratio is at 133.8 for the US, 110.08 for the UK, 115.16 for France and 110.07 for China. India has budgeted for lower market borrowing in FY25, pleasing the bond markets further.
While the supply of paper is reducing, the demand has been good thanks largely to the FPI inflows caused by the inclusion of Indian sovereign bonds in the JP Morgan and Bloomberg bond indices. Foreign portfolio investors have pumped in ₹1,21,059 crore in Indian debt in FY24, anticipating the increase in weights for Indian sovereign securities after this inclusion.
The stability in Indian bond yields could also be, to a large extent, influenced by the stability in the rupee in the last couple of years. A stable currency enhances the returns of global investors. The Indian rupee lost almost 10 per cent in 2022 when the sharp increase in Fed Funds rate caused immense volatility in all financial markets.
But the tide turned for both Indian equity and debt markets in 2023 with net inflow of ₹1,71,107 crore in Indian equity and ₹68,663 crore in Indian debt instruments. The RBI began adding to its reserves using these flows, thus keeping the rupee from appreciating much. The result was that the rupee moved sideways in the range between 81 and 83 against the dollar since the begining of 2023.
What it means
The resilience in sovereign yields spells good news for the RBI. The risk of large foreign fund outflow destabilising the currency and the govt bond yields, tends to play a large role in monetary policy decisions. The RBI typically weighs the impact of its rate hikes or cuts on foreign investors before deciding on the policy rate trajectory. But the differing paths being taken by the bond yields of two countries means that the RBI may not have to worry too much about that.