Prelims 2021

Q. 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.
a) 1 and 2 only
b) 2 only
c) 3 only
d) 1, 2 and 3
Correct Answer: d) 1, 2 and 3

Question from UPSC Prelims 2021 GS Paper

Explanation : 

Factors Influencing Indian Government Bond Yields

Indian Government Bond Yields are influenced by a combination of domestic and international factors, including the actions of central banks and economic conditions such as inflation and interest rates. Here’s an explanation of how each factor influences Indian Government Bond Yields:

Actions of the United States Federal Reserve

The United States Federal Reserve (the Fed) is the central banking system of the United States, and its monetary policy decisions can have a significant impact on global financial markets, including those in India. When the Fed raises interest rates, it can lead to an outflow of capital from emerging markets like India as investors seek higher returns in the US. This can increase the yields on Indian government bonds as prices fall. Conversely, when the Fed cuts rates or engages in accommodative policies, it can lead to inflows into emerging markets, potentially lowering bond yields.

Actions of the Reserve Bank of India

The Reserve Bank of India (RBI) is India’s central bank, and its monetary policy actions directly influence Indian Government Bond Yields. When the RBI raises its key policy rates, it generally leads to higher yields on government bonds, as investors demand higher returns to compensate for the increased cost of borrowing. Conversely, when the RBI cuts rates or signals an accommodative stance, it can lead to lower bond yields.

Inflation and Short-Term Interest Rates

Inflation has a direct impact on bond yields. When inflation is high, investors require higher yields to compensate for the erosion of the purchasing power of their investments. Therefore, rising inflation can lead to higher government bond yields. Similarly, short-term interest rates, which are often influenced by central bank policies, can affect bond yields as they reflect the cost of borrowing money in the economy. Higher short-term rates can lead to higher yields on longer-term government bonds.

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