Global bond yield surge under watch

The finance ministry has flagged the rise in sovereign bond yields worldwide, warning that higher yields could have implications for India's borrowing costs and the rupee. In its economic review for August, the ministry said, "The rise in (global) yield can cut both ways. Our bond yields can rise in tandem. Or, if they don't, the spread compression can put pressure on the domestic currency."

The rise in global bond yields is significant given the growing competition for investment capital worldwide, including from developed economies seeking to finance fiscal spending and refinance existing debt. The ministry said, "This matters for the sustainable level of the current account deficit in developing countries with respect to the ease of financing."

According to the ministry, the rupee has already depreciated by around 5% against the US dollar between February 27 and August 20. However, robust remittance inflows have provided an additional cushion to the external sector and strengthened the resilience of the overall balance of payments.

Market context

Global bond yields have been rising amid concerns over fiscal positions and increased borrowing requirements. The US 10-year Treasury yield rose for a fourth consecutive session to 4.75% on Monday, its highest level since January 2025. The 30-year Treasury yield touched 5.3% last week, its highest level since 2007. In Europe, the 10-year German government bond yield reached a 15-year high amid fresh military escalation between the US and Iran that pushed up oil prices.

In India, the 10-year government bond yield was hovering around 7%, touching 6.95% on Monday. The ministry's warning comes as government bond supply is expected to increase significantly in the second half of the current financial year, potentially putting further upward pressure on yields.

Elevated US Treasury yields can potentially reduce the appeal of Indian securities to foreign investors unless domestic yields rise in tandem. Foreign capital inflows are key to maintaining the current account deficit in developing countries, including India, at sustainable levels.

Inflation risks

Meanwhile, the finance ministry said a possible rise in global average inflation, driven by higher prices of electronic goods and food commodities, poses another challenge for the economy. The ministry said, "These will have implications for our monetary policy, domestic interest rates and the financing of the current account deficit."

Reserve Bank of India governor Sanjay Malhotra had earlier this month underscored the need to be watchful of risks of higher food, fuel and other input prices translating into a broad-based increase in inflation. "Any evidence of these risks materialising may need policy tightening," he had said.

The central bank's monetary policy committee this month kept the benchmark repo rate unchanged for a fourth straight meeting at 5.25%. Retail inflation in July scaled a 19-month peak of 4.45%, driven mainly by elevated price pressure in food but still remaining within the RBI's 2-6% range.

Domestic economy resilient

Amid the external headwinds, the finance ministry highlighted that the domestic economy retained its vigour in July, with demand remaining strong and the external sector displaying stability. The ministry said, "The global economy entered the second half of 2026 on a resilient, though uneven, footing."

Domestic economic activity remained resilient through July, but the pace of expansion moderated in some high-frequency indicators, including manufacturing and services PMI and e-way bill generation. Domestic demand remained firm, with consumption and mobility indicators continuing to record robust growth and freight activity staying resilient.

"Easing input cost pressures provided some relief to business conditions, even as heightened external uncertainties continued to cloud the outlook," the ministry said.

The farm sector activity has stayed broadly stable, but the kharif outlook has been impacted by uneven rainfall. The emergence and persistence of El Niño conditions "warrant close monitoring given their implications for rainfall, crop outcomes and food inflation."

India continued to show unexpected strength in July amid heightened global uncertainty, with total exports of merchandise and services registering strong growth. The ministry cautioned that food prices, weather conditions and global uncertainties need close monitoring in the coming months.

India's foreign exchange reserves stood at $707 billion as of 7 August, providing a comfortable buffer for the external sector.