UPSC Prelims 2021 Q6: What Moves Indian Government Bond Yields
Indian Government Bond Yields are influenced by which of the following?
1. Actions of the United States Federal Reserve
2. Actions of the Reserve Bank of India
3. Inflation and short-term interest rates
Select the correct answer using the code given below.
- 1 and 2 only
- 2 only
- 3 only
- 1, 2 and 3
Answer: (d) 1, 2 and 3
Statement-wise explanation
- 1: correct — Foreign investors can choose between US and Indian bonds, so a Fed rate hike or tighter Fed policy can pull money out of Indian bonds and push Indian yields up. An RBI study (Mint Street Memo No. 16, December 2018) found that a 100 bps rise in the 1-year US Treasury yield raises Indian G-sec yields by about 25–30 bps, with a slightly larger effect on longer bonds. The 2013 'taper tantrum', when India's bond yields and the rupee came under pressure after the Fed hinted at slowing its bond purchases, is the best-known example.
- 2: correct — The RBI sets the repo rate and controls liquidity through open market operations (OMOs), the CRR and the Liquidity Adjustment Facility (LAF). It also manages the government's borrowing programme. The same 2018 RBI study found that the policy rate is a key driver of short-term yields, with about 85–95 bps of pass-through to Treasury bills against roughly 20 bps or less for the 10-year bond. In April 2021 the RBI announced G-SAP 1.0, a ₹1 lakh crore bond-purchase programme for Q1 2021-22, to steady the G-sec yield curve.
- 3: correct — A bond's yield must make up for expected inflation. A nominal yield is roughly the real return plus expected inflation, so when inflation is expected to rise, investors demand higher yields. Short-term interest rates such as the repo rate, call money and T-bill rates anchor the short end of the yield curve. Long-term yields also reflect the short-term rates the market expects in the future.
How to eliminate
This question does not test absolute words. It turns on the option structure. Statements 2 and 3 are textbook facts: the RBI's repo rate and OMOs move bond yields, and so does inflation. If you are sure of both, look for an option containing both. There is no '2 and 3 only' option, so the only code that includes both is the one with all three statements. You do not need to know anything about the Fed. From the other side, (b) and (c) each leave out a basic driver, and (a) leaves out inflation, which is the most fundamental influence on any bond yield. The fact to remember is that in an open economy, domestic bond yields respond to global interest rates (US Treasury yields, Fed policy) through foreign portfolio flows.
Know more
Price and yield move in opposite directions. A G-sec pays a fixed coupon. When its market price falls, its yield (the return to a buyer at that price) rises, and vice versa. Anything that makes investors sell G-secs pushes yields up.
What moves Indian G-sec yields (figures from RBI Mint Street Memo No. 16, 2018):
| Driver | Channel | Evidence |
|---|---|---|
| RBI policy rate | Sets the floor for short-term rates | ~85–95 bps pass-through to T-bills; ≤20 bps to the 10-year |
| RBI liquidity tools (OMO, CRR, LAF, G-SAP) | Buying bonds raises prices and lowers yields | G-SAP 1.0: ₹1 lakh crore, Q1 2021-22 |
| Inflation expectations | Investors demand compensation for lost purchasing power | Nominal yield ≈ real yield + expected inflation |
| Government borrowing | More bond supply means lower prices and higher yields | ~3 bps per 1 percentage point of GDP |
| FPI debt inflows | More foreign demand means lower yields | 10–23 bps lower per 1 percentage point of GDP |
| US yields / Fed | Capital moves to higher returns abroad | 25–30 bps per 100 bps rise in US 1-year yield |
| Crude oil prices | Raise inflation and fiscal worries | Found significant in the same study |
Short end vs long end. RBI policy mostly drives short-term yields. The 10-year yield responds more to non-monetary factors: inflation, fiscal deficit, global rates and foreign flows. This is why the slope of the yield curve changes over time.
Why the Fed matters more now. Indian bonds are increasingly held by foreign investors, through the Fully Accessible Route (2020) and inclusion in global bond indices (2024). As a result, Fed decisions reach Indian yields faster. The 2013 taper tantrum showed this risk.
In the news
In early 2021, US Treasury yields rose sharply and the Fed began discussing tapering its bond purchases. At home, the RBI launched G-SAP 1.0 (₹1 lakh crore, announced 7 April 2021) to cap rising G-sec yields amid record government borrowing.
NCERT Concepts to Revise
- Government securities: The question is about yields on G-secs, so start with what a government security is and who issues it.
- Dated securities: Indian 'government bond yields' usually refers to dated securities such as the 10-year benchmark bond.
- Yield curve: Different drivers act on different maturities; the yield curve shows short-term and long-term yields side by side.