Context:
The BSE Sensex declined for the sixth straight day amid a significant sell-off by FIIs/FPIs, influenced by mixed corporate earnings and worries about the tightening U.S. tariff regime on imports.
Impact of Rising Bond Yield in U.S. on Indian Market
- Higher Returns with Lower Risk:
- Increase in U.S. bond yields lowers the risk-reward ratio of Indian equities.
- FIIs and FPIs reduce equity exposure in emerging markets like India.
- Funds move to safer U.S. bonds.
- Stronger U.S. Dollar:
- Rising U.S. bond yields boost demand for the U.S. dollar, strengthening it.
- A weaker rupee makes Indian assets less attractive to foreign investors.
- FIIs sell Indian stocks and repatriate funds, weakening the rupee further.
- Higher Borrowing Costs for Indian Companies:
- Higher global bond yields lead to increased domestic borrowing rates.
- Indian companies relying on foreign debt face higher interest costs.
- Corporate profitability declines, negatively impacting stock market sentiment.
Bond Yield and Yield Curve
- Bond yield: Return earned from holding a bond until maturity.
- Influenced by interest rates, market demand, and economic conditions.
- Yield curve: Relationship between bond yields and their maturity periods.
Types of Yield Curves:
- Normal Yield Curve:
- Long-term bonds have higher yields than short-term bonds.
- Indicates economic growth.
- Inverted Yield Curve:
- Long-term yields are lower than short-term yields.
- Signals a possible recession.
- Flat Yield Curve:
- Short-term and long-term yields are similar.
- Reflects economic uncertainty.
Difference Between Bond Yield and Interest Rates:
| Aspect | Bond Yield | Interest Rate |
| Definition | Return an investor earns from holding a bond, expressed annually. | Percentage charged by a lender for borrowing money. |
| Application | Relevant to fixed-income securities like bonds, includes interest (coupon) payments. | Applies to loans, bonds, and other debt instruments, determining borrowing costs. |
| Relationship to Market | Inversely related to bond prices. When bond prices rise, yields fall, and vice versa. | Set by lenders or central banks (e.g., RBI) and affects overall borrowing costs. |
| Types | Includes yield-to-maturity (YTM), calculating total expected return on a bond. | Includes nominal, real, and effective interest rates, considering inflation and compounding. |
| Example | A bond with a 10% yield on a $1,000 investment provides a $100 annual return. | A 10% interest rate on a $1,000 loan requires the borrower to pay $100 in interest per year. |
Stock Market
- Definition of Stock Market:
- Platform where shares of publicly listed companies are bought and sold.
- Allows investors to trade company stocks and enables businesses to raise capital.
- Global Stock Markets:
- New York Stock Exchange (NYSE): World’s largest stock exchange.
- NASDAQ: Known for technology stocks like Apple, Microsoft, and Google.
- Indian Stock Markets:
- Bombay Stock Exchange (BSE): Asia’s oldest stock exchange.
- National Stock Exchange (NSE): India’s largest exchange, home to the NIFTY 50 index.
Relation Between Bond Yield and Stock Market:
| Impact | Rising Bond Yields | Falling Bond Yields |
| Stock Market Trend | Bearish (falling stock prices) | Bullish (rising stock prices) |
| Borrowing Costs | Higher interest rates on loans and corporate bonds | Lower interest rates, making borrowing cheaper |
| Corporate Profits | Reduced due to higher borrowing costs | Increased due to cheaper borrowing |
| Investor Behavior | Shift from equities to bonds (attractive fixed-income returns) | Move funds to riskier assets like stocks (less attractive bonds) |
| Inflationary Pressures | Higher inflation expectations, eroding future corporate earnings | Indicates loose monetary policy, promoting economic expansion |
| Monetary Policy | Suggests central banks (RBI, U.S. Fed) are tightening policy | Indicates potential for higher earnings and valuations |
| Currency Impact | Stronger U.S. Dollar, weaker rupee (less attractive Indian assets) | Not applicable |
Source: The Hindu
Previous Year Question
Consider the following statements:
1. Tight monetary policy of US Federal Reserve could lead to capital flight.
2. Capital flight may increase the interest cost of firms with existing External Commercial Borrowings (ECBs).
3. Devaluation of domestic currency decreases the currency risk associated with ECBS.
Which of the statements given above are correct?
[UPSC CSE – 2022 Prelims]
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Answer: (a)
Explanation:
Statement 3 is incorrect: Devaluation of domestic currency does not affect the External Commercial Borrowings as it is denominated in the foreign currency and not in the domestic currency.