Rising US bond yield may put pressure on RBI to hike rates

Bond yields in US are now up 136 bps from their lows in May this year

The yield on the 10-year US government bond has risen to a two-year high and is now just shy of three per cent, as investors worry about a likely withdrawal of monetary stimulus by the Federal Reserve. Including the nine basis point rise on Thursday, bond yields in the US are now up 136 basis points (bps) from their lows in May this year. Yields refer to the interest income that a bond holder receives if she/he buys it at current price and holds it to maturity.

Experts say this would put pressure on the Reserve Bank of India (RBI) to raise interest rates in India, to maintain the spread between the bond yield in India and the US. The yield spread — the difference in the interest rate that a government bond in India pays over the US government bond — has narrowed in recent weeks as yield in India has failed to keep pace with the rise in US. Bond yield in India are up only 88 bps since May this year, around half the rise in US. The yield spread was 565 bps on Friday from a high of 636 bps in the middle of last month and a little over 600 bps at the beginning of May this year. One hundred bps make one per cent.

“The rise in US yield is an indication that interest rates are rising globally and it is here to stay. Ultimately, it will get transmitted to India either through imported inflation due to high energy and commodity prices or through higher cost of foreign capital,” says Deep Narayan Mukherjee, director (ratings) at India Ratings, the domestic credit rating arm of global rating agency Fitch.

It may take time for the central bank to raise the benchmark interest rates in the response, but it will start showing up in the real economy sooner than later, he adds.

Analysts agree. “We can’t have a situation where bond yields or the interest rates in the US keep rising while that in India remain flat or fall. We expect interest rates to harden further in India in line with the global trend,” says Dhananjay Sinha, co-head (institutional equity) at Emkay Global Services. If the RBI drags its feet on raising benchmark rates, the transmission will happen through currency depreciation, he says.

According to experts, RBI has to be mindful of elevated level of consumer inflation in India while taking a stance on the interest rate.

“A persistently high level of consumer inflation meant that interest rate have been negative for most of the last five years. This is unsustainable and has to correct soon,” says mukherjee.

Some disagree and say that a lot depends on the upcoming meeting of the

The US Federal Open Market Committee slated for the  18th of this month. “There is a lot of uncertainty in the global markets right now regarding the Fed monetary stance. This is causing market volatility, making it tough for policy makers in emerging markets to take a firm stance on interest rates,” says Arun Kumar R, vice-president (India credit) at Nomura.