Japan bond yields rise, but no immediate spillover seen on Indian bond market

Bonds

Japan’s government bond yields have edged higher in recent days as investors price in the impact of a fresh fiscal stimulus and a gradual uptick in core inflation, but the Indian bond market remained immune to this in the near term, experts said.

This is because the Indian bond market has been lately following the domestic factors, such as liquidity conditions, government borrowing dynamics and cues from the upcoming Reserve Bank of India (RBI) monetary policy, rather than global cues. The RBI is widely expected to prioritise liquidity management and stability rather than respond to Japan-driven market signals.

No immediate risks

“We do not foresee any immediate risks to India's bond yield, which will be more driven by liquidity concerns and the upcoming monetary policy of the RBI,” said Dipanwita Mazumdar, Economist at Bank of Baroda.

Historically, India’s bond market reacts more to US Treasury yield movements than Japanese rate shifts. However, the movement in yield on the latter could lower the inflows into advanced and emerging market economies.

Significance of Japan

Japan is one of the world’s largest creditor-nations and plays an important role in capital flows to other countries. Thus, a rising yield can influence other markets in a significant way.

A modest rise in the Japanese bonds that has lived with near-zero rates for decades can send a ripple across global economies. As Japan's bond yields become more attractive, Japanese investors may sell foreign assets and bring capital back home. This can put downward pressure on prices and upward pressure on yields in overseas bond markets. Bond yields and prices have an inverse relationship. When bond yield rises, prices fall and vice-versa.

Despite this, the ripple effect from Japan's bond yield was not visible on the Indian bond market due to the demand from domestic investors, such as insurance companies, pension funds and mutual funds.

How India has fared

The Indian benchmark bond yield has seen a moderation so far in this month by 5-7 basis points (bps) amid comfortable liquidity in the banking system and good domestic investor demand. Currently, the 10-year benchmark bond yield is trading at 6.5122 percent.

However, foreign investor flows into the debt FAR (Fully Accessible Route) segment remained muted so far in November after heavy inflows in the previous two months. This is a reflection of the rising global bond yields, especially on the Japan bonds.

Higher developed-market yields typically reduce the relative attractiveness of emerging market debt, prompting investors to book profits or pare back exposure.

Way forward

Experts said that the bond market is likely to take cues from the upcoming monetary policy and yields may ease further, if the central bank opts for a rate cut, which is widely expected.

Usually, when the central bank reduces the repo rate, the money market instruments sees a fall in yield, leading to rising prices. In anticipation of a rate cut, most investors lock in funds at higher yields to get the benefit of higher prices after the rate cut.

On November 21, a Moneycontrol poll of 18 economists, treasury heads and fund managers said that the MPC (Monetary Policy Committee) of the RBI is likely to cut repo rate by 25 basis points (bps) in the upcoming monetary policy due to the comfort provided by the lowest ever Consumer Price Index (CPI) inflation in the last two months.

If a rate cut happens in December, it will be the first reduction by the central bank after maintaining status quo in the last two policies.

The RBI has so far reduced repo rate by 100 bps from 6.5 percent to 5.5 percent between February and June. After that, the RBI MPC has maintained a status quo in August and October policy meetings.

The MPC will meet between December 3 and 5 for another round of rate-setting deliberations.

On November 24, RBI Governor Sanjay Malhotra said macroeconomic indicators are looking good and there is scope for a repo rate cut as communicated in the October monetary policy.

"In October, the MPC  said there is scope for a further rate cut. Since then, whatever data we have received in terms of macroeconomic indicators do not reduce the scope for a rate cut. There is  scope for a further rate cut, but it is up to the MPC to decide on a rate action in the December policy,” Malhotra said during an interview with Zee Business.