UPSC Prelims 2021 Q6: Indian Economy – Financial Markets & Capital Markets
- (a) 1 and 2 only
- (b) 2 only
- (c) 3 only
- (d) 1, 2 and 3
Answer: (d) 1, 2 and 3
Explanation
What Drives Indian Government Bond Yields?
| Factor | Impact on G-Sec Yields | Mechanism |
|---|---|---|
| 1. US Fed actions | YES - Direct impact | US Fed rate hikes cause FPI outflows from Indian bonds, rupee depreciation, and force RBI to raise rates - lifting yields. Global bond markets are interconnected. |
| 2. RBI actions | YES - Primary domestic driver | RBI's repo rate changes, Open Market Operations (OMO), Operation Twist, LAF/MSF corridor and CRR/SLR all move G-Sec yields directly. |
| 3. Inflation + short-term rates | YES - Foundational | Bond yields = real yield + inflation expectations + risk premium. Rising inflation forces higher yields; short-term rates (repo, T-bill) anchor the yield curve. |
All three factors influence Indian G-Sec yields.
Answer: (d) 1, 2 and 3.
Why each option is right or wrong
- (a) Incorrect. Missing factor 3 - inflation is the single biggest driver of bond yields globally.
- (b) Incorrect. RBI is a key driver but not the only one - US Fed and inflation matter equally.
- (c) Incorrect. Yields respond to more than just short-term rates - RBI actions and global spillovers matter too.
- (d) CORRECT. All three - US Fed (global spillover, FPI flows, rupee), RBI (repo, OMO, LAF), and inflation/short-term rates (yield curve foundation) - move Indian G-Sec yields.
Key point
G-Sec yields driven by: (i) US Fed (FPI flows, rupee, spillover), (ii) RBI (repo, OMO, LAF), (iii) inflation + short-term rates (yield curve). All three matter. Bond yield = real yield + inflation expectation + risk premium.
Remember
Indian Government Bond Yields are influenced by all three: US Federal Reserve actions (global spillover, FPI flows, rupee), RBI actions (repo, OMO, LAF, CRR/SLR), and inflation plus short-term interest rates (which anchor the yield curve).
Common mistakes
- Thinking Indian bond yields are only domestically determined. FPIs hold ~2% of G-Secs and their flow (driven by Fed policy) matters at the margin.
- Not knowing the bond price-yield inverse relationship. When yields RISE, bond prices FALL. This affects banks' investment portfolios and mark-to-market losses.
- Confusing repo rate (RBI's short-term policy rate) with G-Sec yield (market-determined return on government debt).
Exam tip
Bond yield formula: Yield = Real yield + Inflation expectation + Risk premium. When US Fed hikes, capital flows out of India, rupee weakens, RBI hikes rates, and G-Sec yields rise. All linked. Master this chain for macro questions.
Sources
- RBI Bulletin - Government Securities Market
- Economic Survey - Monetary Management and Financial Intermediation