Rising bond yields and investors in India

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  Rising bond yields and investors in India

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1. Investors watching yields: The year 2020 was good for Indian stock investors, who saw their wealth rise sharply. That was due to easy monetary policy globally. But soon, the link between US bond yields and markets in India started appearing. Indian markets started seeing volatility in 2021.
2. Why US bond yields started rising in 2021: The US saw an economic recovery and a potential return of inflation, leading to a surge in bond yields. These yields had sunk in mid-2020 as the Federal Reserve loosened monetary policy to support the US economy (due to covid-19 pandemic). Now in 2021, the US Fed is expected to "normalise its stance" as inflation rises (so it will raise the benchmark interest ratE). Also, the prices of commodities have moved up sharply over the past few months, and this may lead to much higher inflation. The yield on the benchmark 10-year Treasury note has moved from 0.91% at the start of calendar year 2021 to 1.72% on 19 March 2021.
3. Why shares are affected: Higher bond yields do two things - (1) Government bond yields are taken as the ‘risk-free rate’ that is used to discount cash flows of companies. Future cash flows are less valuable than present cash flows and the discount rate allows them to be compared with present cash flows. The higher the risk-free rate, the higher is the discounting factor and hence the lower is the valuation of the stock (so investors will be spooked), and (2) Higher yields mean higher borrowing costs (in the present) for companies, reducing the earnings available for shareholders as dividends.
4. Indian markets impacted: Capital flows from one country to another, and interest rate increases in large economies both affect other large economies. The US is a source of flow into equity markets of the world, including India, and a rise in rates in the US makes keeping money in domestic bonds lucrative for US investors. So they won't invest as much as earlier, in Indian paper.
5. The good and the bad: Companies with a lot of debt are at risk from rising interest rates. If bond yields in the US also eventually push up yields in India, this can affect the returns of such companies by increasing their borrowing costs. Rising US yields can also cause a depreciation of the rupee and this weakens the position of companies with borrowings in US dollars. Conversely, sectors such as pharma and tech with earnings in dollars can benefit from rupee depreciation.
6. Peep into the future: Many expect monetary policy from the world’s central banks to remain accommodative and hence bond yields to remain broadly low. There may be no reason to act in haste. Investors may want to have some of their portfolio in dollar-linked assets such as US stocks to partially hedge their risk. This can be done through mutual funds investing in the US or directly buying US stocks and bonds through RBI’s Liberalised Remittance Scheme.

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