Bond Yields – Why rising bond yields can be a tough proposition?

In the last few weeks, the benchmark Indian 10-year bond yields have very quietly moved up to above 7.1%. That is a full 185 bps above the repo rate, which is too high by past standards. In fact, higher bond yields have larger implications.

Why are Indian 10-year bond yields moving up?

Rising bond yields are not just an Indian phenomenon. Even the US is seeing bond yields moving close to the 5.0% mark. Higher bond yields are indicative of a sharply higher inflation risk in the economy. With Brent Crude prices at $105/bbl and food prices under pressure due to weak monsoons, inflation expectations are definitely higher. For August 2026, the rate of CPI inflation is expected in the range of 4.8% to 4.9%. It will be the third successive month of inflation above the RBI median target of 4.0%. This raises the chances of the RBI front-loading rate hikes in the October policy itself.

Impact of higher yields on debt products

Higher bond yields on the benchmark has two implications for debt products. On the one hand, loans are likely to get costlier, so borrowers may end up paying higher EMI on their variable interest loans. Even businesses will struggle to raise money at economical rates of interest if the bond yields are surging. But the biggest impact will be on the bond holdings of the banks and insurance companies. The Indian debt market is a $2.75 trillion market and a big chunk of these bonds are at the longer end of the yield curve. Such longer duration bonds are more vulnerable to a rise in bond yields. That is where, the portfolio impact will show up in the coming quarters.

Will be a hit on equity valuations too

The impact of higher bond yields is not just being felt on bonds, but on equities too. There are 3 reasons why equities are getting impacted by higher bond yields. Firstly, higher bond yields mean Indian companies will be borrowing at higher cost of funds. That will squeeze their margins and put pressure on their interest coverage ratios. Secondly, equities are evaluated based on earnings yield, which is the reverse of the P/E ratio. At a P/E of 20X, the earnings yield is 5%. However, if the yield on bonds go above 7%; investors will prefer the safety of bonds over equities. Above all, higher yields raises the weighted cost of capital and. Being a discounting factor, it depresses equity valuations.

Higher yields will still not help FPI inflows

One argument is that higher bond yields will attract FPI flows into Indian bonds. However, that is not happening, and it is unlikely to happen for two reasons. Firstly, there is the yield spread challenge that Indian bonds are faced with. For instance, Even as Indian benchmark bond yields have crossed 7%, the US bond yields re getting close to 5%. This 200-210 bps spread is one of the lowest spreads seen. That is not attractive enough for FPIs to commit funds to Indian bonds. Secondly, currency risk is a big overhang for FPIs to commit long-term money to India. Despite the heavy FCNR(B) flows, the rupee has not shown visible signs of bottoming out. Higher bond yields are hurting where it matters!