Narrowing of US, Indian 10-year treasury yields to impact FPI inflows

Indian 10-year government securities closed at 6.78 per cent on Thursday, while US 10-year treasuries were trading at 4.54 per cent

The narrowing spread in yields between US 10-year treasury bonds and Indian 10-year government securities, nearly the lowest in 20 years, is likely to have an impact on foreign portfolio investor (FPI) inflows into India’s government debt and could even lead to outflows, according to economists and market experts.

 

US 10-year yields have moved up following the US Federal Reserve’s hawkish tone, revising its guidance on possible rate cuts in calendar year 2025 to 50 basis points (bps) from 100 bps earlier, and raised the inflation forecast after cutting rates by 25 bps, which was in line with market expectations, leading to a surge in US yields.

 

 

Indian 10-year government securities closed at 6.78 per cent while US 10-year treasuries were trading at 4.54 per cent. The spread stands at 224 bps, the lowest since April 1, 2005.

 

According to Gaura Sen Gupta, chief economist, India First Bank, this could lead to FPI outflows from Indian government debt. In October and November, there were outflows from securities under the fully accessible route (FAR), and a further narrowing of spreads could result in net outflows on this count.

 

According to the data from Clearing Corporation of India (CCIL), FPIs were net sellers of government securities designated under the fully accessible route in October and November. They sold a net amount of around Rs 5,187 crore in November and in October it was Rs 5,142 crore.

 

October saw the first net outflow from FAR securities since April.

 

“There is a positive supply-demand dynamic for Indian government bonds, supported by robust domestic factors such as a narrow fiscal deficit and strong investor demand. This has limited the rise in Indian government security yields. Having said that, upward pressure on US yields is expected to persist, as the Fed appears hawkish and there is ongoing uncertainty on the fiscal front under Donald Trump, who will be US President next month,” Sen Gupta said.

 

A higher spread makes Indian debt more attractive to FPIs because it compensates them for taking on currency risks. According to experts, the spread has averaged 350-400 bps over the past two decades.

 

“US interest rates remained low for nearly 15 years following the Lehman crisis (2008). With the Fed now normalising rates, they are rising. While the markets had priced in a 100 basis point hike in 2025, the Fed’s hawkish tone has led to a revision, with only a 50 basis point hike now being priced in. As a result, upward pressure on US yields is expected to continue,” said a treasury head at a private-sector bank.

 

According to Madan Sabnavis, chief economist, Bank of Baroda, the spread has averaged 300-350 bps. However, since the Ukraine crisis erupted in early 2022, US 10-year yields have risen significantly, while India’s 10-year yields have remained range-bound due to the central bank’s liquidity management.

 

"Following the rate cut by the Fed, the spread has narrowed to a near-two-decade low, which could lead to FPI outflows and put pressure on the domestic currency. While there is no specific ideal spread, a larger differential is preferred because it tends to attract inflows into India,” Sabnavis said.

 

The rupee on Thursday breached the psychologically crucial 85 per dollar mark after the US Federal Reserve meeting because the Fed indicated a measured pace for future rate reductions.

 

“The narrowing spread will likely impact FPI inflows into Indian government securities, as such narrow spreads may not compensate FPIs for risks in Indian bonds,” said Gopal Tripathi, head of treasury and capital markets, Jana Small Finance Bank.