As rupee falls, spread between India and US bond yields tightens | Business Standard News

Clipped from: https://www.business-standard.com/article/finance/as-rupee-falls-spread-between-india-and-us-bond-yields-tightens-122071401286_1.html

In comparison, the recent decline in the yield spread is because bond yields in the US have risen faster than in India

Indian rupee

Photo: Bloomberg

The Reserve Bank of India (RBI) may have to ultimately raise interest rates to stem capital outflows from India and shore up the rupee that continues to depreciate at a steady pace. The yield spread between the 10-year Government of India (GoI) bond and the benchmark US Treasury remains low when compared with the historical average.

The yield on the benchmark GoI bond is currently 447 basis points higher than that on the 10-year US treasury bond; this is 81 basis points lower than the historical average spread of 528 basis points since 2010. In fact, the yield spread was 494 basis points at the end of December last year.

The spread had widened to 690 basis points in the last quarter of 2012 when the rupee had come under attack because of monetary tapering by the US Federal Reserve.

In comparison, the recent decline in the yield spread is because bond yields in the US have risen faster than in India. The yield on the 10-year US Treasury is up 140 basis points since the beginning of this calendar year; during this period, the yield on the 10-year GoI bond is up 93 basis points.

According to analysts, a narrower spread makes it less attractive for foreign investors to invest in rupee assets and this may have contributed to a sell-off by foreign portfolio investors (FPI) and downward pressure on the rupee.

ALSO READ: Explained: What happens if the rupee hits 80 against the US dollar

The rupee has depreciated 6.8 per cent against the dollar since the beginning of the current year — one of its worst showings in a seven-month period since the 2013 taper tantrum. The domestic currency closed at Rs 79.88 versus the dollar on Thursday, against Rs 74.47 at the end of December 2021.

Chart

The rupee had gained 0.3 per cent against the dollar during the first seven months of the 2021 calendar year.

The Indian currency is facing headwinds from a continued sell-off by FPIs and a rising trade deficit, resulting in a sharp decline in foreign exchange reserves, which are down nearly $50 billion from their highs.

In response, the RBI announced a slew of regulatory measures to make it easier and cheaper for banks and corporations to attract and raise forex deposits and loans early this month. The central bank also made it easier for FPIs to invest in government securities.

Analysts, however, doubt the effectiveness of such measures in the absence of a rate hike. “It is unlikely to result in large FPIs inflows into G-Secs, given the elevated and rising public debt/GDP ratio at 80-82 per cent, the narrowing spread between Indian G-Sec and US Treasury yields, and potential INR/USD depreciation,” wrote Dhananjay Sinha and Hitesh Suvarna of JM Financial in their recent report.

According to them, there is a risk of another $40-50 billion decline in India’s forex reserves in FY23E, putting more pressure on the rupee.

“The risk of widening current account deficit, declining capital account balance, and the RBI being forced to allow greater currency flexibility can result in a sharper currency depreciation beyond our projection of 80-82,” they added.

“Given rate hikes and monetary tightening by the Fed, India will have to do everything it can to attract more dollar inflows. These measures include raising interest rates and discouraging imports,” said G Chokkalingam founder & MD of Equinomics Research & Advisory Services.

In the past, many countries had resorted to sharp hikes in interest rates to protect their currencies. Russia’s central bank raised the interest rate to 20 per cent, from 9.5 per cent in February this year as the ruble depreciated sharply after the country attacked Ukraine. In contrast, Turkey, which has refused to raise interest rates, has seen a sharp decline in the value of the Turkish lira against major currencies.

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