India-US Yield Gap at 20-Year Low Raises Doubts of Fund Outflows

For the first time in two decades, the gap between Indian and US 10-year government bond yields has shrunk to a record low. That's raising red flags about possible foreign investment outflows from India's debt markets, and the ripple effects could be significant.

Historic Compression of Yield Spread

On April 11, 2025, the yield difference between Indian and US 10-year bonds dropped below 200 basis points, landing at just 194.5. Compare that to the usual spread of 350–400 points over the past 20 years, and it's clear something's shifting.

This narrowing is mainly due to rising US yields, driven by the Federal Reserve's aggressive stance. The Fed plans to cut interest rates by just 50 basis points in 2025, half of what was initially expected. Meanwhile, India's central bank, the RBI, has stayed steady with more supportive policies. As of April, Indian 10-year bonds yield about 6.44%, while US ones are close to 4.49%.

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Implications for Foreign Investment

When the yield gap narrows, India's bonds look less attractive to global investors. After all, why take on emerging market risks for only a slightly better return? This situation isn't new; something similar happened in 2013 during the "taper tantrum," when India saw $7.9 billion in foreign outflows and an 11% drop in the rupee.

We're already seeing some repeat signs. In January 2025, foreign investors pulled $705.5 million from Indian bonds in just one day, the biggest single-day exit since 2020. From February 7 to 24, investments under the Fully Accessible Route (FAR) dropped by nearly ₹9,000 crore. The reasons? A weakening rupee and that shrinking yield bonus.

Rupee Under Pressure

India's currency isn't immune. On May 20, the rupee fell by 16 paise, ending at 85.58 to the US dollar. It had gained 15 paise just a day earlier, so the drop reversed that progress fast. Weak stock markets and rising US bond yields are part of the mix, adding pressure to the rupee and investor nerves.

Experts are paying attention. Uday Kotak of Kotak Mahindra Bank pointed out how unusual it is for Indian bond yields to get so close, or even fall below, US yields. That could shake up how investors view emerging markets like India.

Still, there's some optimism. Anubhuti Sahay from Standard Chartered noted that while these kinds of shifts often spark outflows, India's strong economic foundation and sound policy choices could cushion the blow.

Mitigating Factors

Despite the concerns, not everything is gloomy. In March 2025, India saw ₹40,000 crore flow into its debt markets, thanks partly to its addition to global bond indices and expectations of future rate cuts. And with foreign exchange reserves at a record $648.56 billion, India has a solid buffer if things get rough.

Conclusion

India's shrinking yield gap with the US is more than just a number; it's a signal. It points to shifting global trends and poses real challenges for stabilising foreign investment and the rupee. But thanks to strong fundamentals and international confidence, India's still holding its own. That said, policymakers must stay alert and ready to act as the global financial story unfolds.