Why in the News?
- The Reserve Bank of India's annual report for 2025-26 has flagged concerns over elevated sovereign bond yields and possible reversal of monetary easing by global central banks, signalling the end of the era of cheap global money and its implications for India.
What’s in Today’s Article?
- Govt Bonds & Yields (Meaning, Quantitative Easing, Era of Cheap Money, Reasons for Cheap Money)
- Current Scenario (End of Cheap Money, Reasons, Implications for India, Govt Measures, Challenges, Way Forward)
Understanding the Concept of Government Bonds and Yields
- A government bond is a debt instrument issued by a sovereign authority to borrow money for a specific period.
- In return, the issuer promises to pay a fixed annual interest over the bond's life and repay the original borrowed amount at maturity.
- Government bonds are considered "risk-free" assets as their payments are backed by the sovereign's power to tax or print money.
- Bond yields, the effective annual interest rate, serve as a benchmark for setting interest rates across other fixed-income securities, establishing the minimum return investors expect for their money over a comparable period.
Quantitative Easing (QE)
- Quantitative Easing is a monetary policy tool used by central banks to stimulate the economy.
- Under QE:
- Central banks create new money to purchase government bonds and long-term assets from commercial banks.
- The objective is to flood the financial system with liquidity.
- It aims to lower long-term interest rates and encourage banks to lend more.
- QE was extensively used after the 2008 Global Financial Crisis and during the COVID-19 pandemic.
The Era of Cheap Money: A Historical Perspective
- Bond Yield Trends in Major Economies
- Over the past two decades, bond yields in major economies have witnessed a dramatic decline. Late 1990s and early 2000s:
- US: Over 6%; UK: 5.4%; Japan: 1.7%;
- During the COVID-19 pandemic (2020-21):
- US: 0.9%; UK: 0.4%; Japan: Practically zero
- Negative Yields Phenomenon
- Japan even witnessed negative bond yields in 2016-17 and 2019-20, meaning investors were willing to pay the Japanese government to keep their money. Negative yields are possible in scenarios of:
- Deflation (falling prices of goods and services)
- Currency appreciation expectations
- Extreme economic uncertainty, where investors prioritise safety over returns
Why Money Was Cheap?
- During this period, central banks maintained ultra-low interest rates and pursued aggressive quantitative easing to revive economies battered by:
- 2008 Global Financial Crisis; COVID-19 pandemic; Persistent low inflation in developed economies
- This created an environment of abundant global liquidity, with capital flowing freely into emerging markets like India in search of higher yields.
The Current Scenario: End of Cheap Money
- Rising Bond Yields: Bond yields have risen significantly in 2025-26:
- Japan: Average of 1.8% in 2025-26, rising to 2.5% in the current fiscal, with a high of 2.8% in May 2026.
- US: Average of 4.2%, rising to 4.4%, with a high of 4.7%.
- UK: Average of 4.6%, rising to 4.9%, with a high of 5.2%.
- This marks a sharp departure from the near-zero yields that characterised the post-2008 era.
Reasons for Global Money Becoming Expensive
- Return of Inflation: A series of global disruptions has brought inflation back:
- COVID-19 supply chain disruptions (2020-21)
- Russia's invasion of Ukraine (2022)
- US tariff actions under President Donald Trump (2025)
- US-Israel versus Iran conflict (ongoing)
- The prospect of further inflation due to higher fuel, fertiliser, and food prices from the West Asia supply shock has made ultra-low interest rates unsustainable.
- End of Quantitative Easing: The QE policies that drove cheap money have ended for several reasons:
- Inflationary consequences of new money supply growing faster than physical production
- Excessive government borrowing due to artificially low rates
- Unsustainable public debt levels taken on by governments
- The combined effect of high inflation and elevated public debts is now reflected in rising sovereign bond yields globally
Implications for India
- Capital Flow Trends: The end of cheap global money has significant implications for India's capital flows:
- Net Capital Inflows
- 1998-99: $8.3 billion
- 2007-08: Record $107.9 billion
- 2008-09: Collapsed to $7.8 billion during the financial crisis
- 2009-10 to 2023-24: Averaged $67.3 billion annually
- 2024-25: Just $18 billion
- First nine months of 2025-26: Net capital outflows of $580 million
- Foreign Portfolio Investor (FPI) Outflows: A striking trend is visible in FPI flows into Indian equity markets:
- From 1998-99 to 2020-21, only two years witnessed net negative inflows: 2008-09 and 2015-16.
- Since 2020-21, five out of six years have witnessed FPIs pulling out more money than they put in.
- Narrowing Yield Differential: A critical concern is the narrowing yield differential between India and the US:
- India's 10-year government bond yields: Around 7%
- US 10-year Treasury yields: Around 4.5%
- Current differential: 2.5 percentage points
- Historical decade average: 4+ percentage points
- When adjusted for rupee depreciation and the "safe-haven" value of US Treasuries, the effective yield gap becomes even smaller, making Indian assets relatively less attractive to foreign investors.
Challenges for India's Economy
- Pressure on capital inflows: Foreign capital may become harder to attract.
- Currency pressure: Lower inflows can weaken the rupee.
- Higher borrowing costs: Indian companies and the government may face higher costs of raising foreign funds.
- Stock market volatility: Reduced FPI flows can affect Indian equity markets.
- Current account financing: Persistent current account deficits become harder to finance.
India's Strategic Response
- To attract foreign capital in this changed environment, India needs to offer a more compelling "pull" story rather than relying on the "push" from cheap global money. This requires:
- Higher GDP and earnings growth prospects.
- Macroeconomic stability with controlled inflation and fiscal deficits.
- Structural reforms to boost manufacturing and exports.
- Deeper financial markets to attract long-term capital.
- Policy predictability and investor-friendly regulations.
- Enhanced ease of doing business.
Concerns Raised by Experts
- The RBI's annual report flagged worries about elevated sovereign bond yields and possible reversal of monetary easing by global central banks.
- Experts have described the end of quantitative easing and near-zero interest rates as "perhaps the single most consequential development in global capital markets" in recent times.
- The combination of persistent inflation and high public debt in developed economies is unlikely to allow a quick return to the cheap money era.
Way Forward
- RBI interventions to manage currency volatility.
- Targeted policy measures to attract FPI flows.
- Diversification of funding sources for the government and corporates.
- Strengthening forex reserves as a buffer.
- Boosting manufacturing exports through PLI and Make in India schemes.
- Deepening domestic savings to reduce dependence on foreign capital.
- Attracting stable FDI through structural reforms.
- Developing bond markets to provide alternatives for foreign investors.
- Enhancing competitiveness through labour, land, and capital market reforms.
