Question map
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.
Explanation
The correct answer is Option 4 (1, 2 and 3) because Indian Government Bond Yields are influenced by a combination of global monetary policies, domestic regulatory actions, and macroeconomic indicators.
- Actions of the U.S. Federal Reserve: In a globalized economy, a rate hike by the Fed often leads to capital outflow from emerging markets like India. To prevent currency depreciation and remain attractive to investors, Indian bond yields typically rise in tandem.
- Actions of the Reserve Bank of India (RBI): The RBI’s monetary policy, specifically changes in the Repo rate and Open Market Operations (OMO), directly impacts liquidity and bond prices. When the RBI raises rates, bond yields increase.
- Inflation and short-term interest rates: Inflation erodes the purchasing power of fixed-income returns. High inflation leads investors to demand higher yields to compensate for risk, while short-term interest rates set the baseline for the overall yield curve.
Since all three factors fundamentally dictate the demand and pricing of government securities, they all influence bond yields.
PROVENANCE & STUDY PATTERN
Full viewThis is a classic 'Applied Macroeconomics' question. While Statements 2 and 3 are direct NCERT static theory, Statement 1 tests your understanding of the 'Open Economy'—specifically how global liquidity spills over into domestic markets. If you understand the 'Why' behind news headlines (e.g., 'Fed Tapering'), this was a sitter.
This question can be broken into the following sub-statements. Tap a statement sentence to jump into its detailed analysis.
- Statement 1: Do actions of the United States Federal Reserve influence Indian government bond yields?
- Statement 2: Do actions of the Reserve Bank of India influence Indian government bond yields?
- Statement 3: Does inflation influence Indian government bond yields?
- Statement 4: Do short-term interest rates influence Indian government bond yields?
- Directly links Fed tapering announcements to higher US T-bond yields and capital withdrawal from emerging markets, a channel that can raise domestic bond yields.
- Implies Fed policy tightening (or tapering) has real effects on emerging-market asset prices and investor flows, which affect local bond markets.
- States that US quantitative easing influenced asset price bubbles in emerging economies, indicating Fed policy affects emerging-market assets.
- Notes that speculation of Fed 'tapering' caused stress in emerging-market currencies—another transmission channel to bond markets via capital flows and exchange rates.
- Shows empirical analyses of Indian asset prices include US Federal Reserve data and the 10-year US Treasury yield, indicating researchers treat US monetary policy as relevant to Indian yields.
- Using the US 10-year yield as 'interest rate abroad' implies a transmission channel from US policy/rates to Indian financial variables.
The exam question explicitly lists 'Actions of the United States Federal Reserve' as a possible influence on Indian government bond yields, indicating that textbooks treat Fed actions as a candidate factor to consider.
A student could take this as a prompt to check historical episodes (e.g., Fed tightening) and compare timing with Indian yield moves and capital flows.
Explains that increased foreign investment in Indian government bonds (via global bond indices) lowers yields — showing that international capital flows into Indian bonds affect yields.
A student can combine this with the fact that Fed policy affects global yields and investor risk/return, so Fed-induced capital flow changes could alter foreign demand for Indian bonds and thus yields.
States that changes in US/EU interest rates influence RBI foreign-exchange operations (RBI likely to buy dollars if US/EU rates fall), implying RBI reacts to foreign interest-rate moves.
One could infer that if RBI adjusts FX/reserve operations in response to Fed moves, those operations (which affect liquidity) may in turn influence domestic bond yields.
Notes RBI's Foreign Currency Assets are largely invested in US government bonds, directly linking RBI balance-sheet exposure to US government debt and yields.
A student could reason that Fed actions that change US bond yields affect the value/returns on these assets and potentially RBI policy or reserve management, with knock-on effects for domestic interest rates and yields.
Describes RBI open market operations (buying/selling government bonds) as a tool that influences money supply and yields — showing how central bank actions can directly move domestic yields.
Combining this with the idea that foreign central-bank (Fed) actions alter global liquidity/interest conditions, a student could investigate whether Fed moves prompt RBI OMOs that then change Indian yields.
- Defines Open Market Operations (buying/selling government bonds) as an RBI tool to influence money supply.
- Explains RBI buys government bonds in the open market and pays for them, directly affecting bond demand and liquidity.
- Link between RBI bond transactions and money supply implies impact on bond prices and yields.
- Describes repo and reverse repo operations as the main monetary policy tools used by RBI.
- States RBI can change the rate at which it lends to banks (bank rate), altering borrowing costs and liquidity in the banking system.
- Changes in liquidity and short-term interest rates influence broader interest rate structure, including government bond yields.
- Notes RBI purchases Indian government bonds under OMO and holds interest-bearing government securities.
- Records RBI's role as 'Debt Manager' of the central government, linking RBI operations to government borrowing and bond market functioning.
- Shows institutional mechanisms through which RBI actions can affect supply-demand and yields in the government bond market.
- Explains that inflation causes losses to bond holders because bonds pay fixed nominal returns.
- Makes explicit the mechanism: fixed nominal payoffs lose real value when inflation rises.
- Directly links inflation to the real return profile of bond investors (hence to bond valuations/yields).
- Describes inflation-indexed bonds where interest and principal are protected against inflation.
- Implicates that standard bond structures are sensitive to inflation, motivating inflation-protected variants.
- States that Inflation Indexed Bonds provide constant return irrespective of inflation and protect investors.
- Confirms inflation is a macro risk for bond holders that IIBs are designed to mitigate.
- States bond prices fall when bank interest rates rise, implying yields (inverse of price) move with short-term rates
- Explains market trading based on expected future short-term rate changes, linking short-term rates to bond-market price adjustments
- Explicitly asserts bond prices are inversely related to the market rate of interest, a core pricing relationship
- Highlights role of expectations about future market (short-term) interest rates in driving bond price and yield changes
- Notes floating-rate bonds can be linked to Treasury bill yields, showing a direct mechanical link between short-term rates and bond interest payments
- Connects short-term T-bill yields (a short-rate benchmark) to the interest/coupon behavior of government securities
- [THE VERDICT]: Sitter for conceptual learners; Moderate for rote learners. Statements 2 & 3 are direct NCERT (Macro Ch 3). Statement 1 is standard financial news logic.
- [THE CONCEPTUAL TRIGGER]: Monetary Policy Transmission & Bond Market Dynamics. The core theme is 'What moves the price of money?'
- [THE HORIZONTAL EXPANSION]: Memorize these Bond siblings: 1) Bond Yield vs. Price (Inverse relation), 2) Yield Curve Inversion (Recession signal), 3) Operation Twist (RBI buying long/selling short), 4) Masala Bonds (Rupee denominated), 5) VRR (Voluntary Retention Route for FPIs).
- [THE STRATEGIC METACOGNITION]: Stop reading definitions in isolation. When you read 'RBI hikes Repo Rate', immediately force yourself to think: 'How does this hit Bond Yields? How does this hit the Rupee?' UPSC tests the *chain reaction*, not the definition.
Foreign purchases of Indian government bonds alter demand and therefore change Indian government bond yields.
High-yield for UPSC: explains how global capital movement affects domestic interest rates and government borrowing costs; links to topics on external financing, capital controls and bond market reform (e.g., Global Bond Index inclusion). Enables answers on causes of yield changes and policy responses to capital flow volatility.
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > Indian Govt. securities will very soon join Global Bond Index > p. 48
RBI's buying or selling of government securities changes liquidity and the domestic money supply, which affects government bond yields.
Essential for monetary policy questions: shows the direct tool through which the central bank influences yields and liquidity, connects to inflation control, repo operations and government debt management. Useful for questions on how policy actions affect financial markets.
- Macroeconomics (NCERT class XII 2025 ed.) > Chapter 3: Money and Banking > 3.4 POLICY TOOLS TO CONTROL MONEY SUPPLY > p. 42
RBI's holdings of US government bonds and foreign-currency assets link India to international interest returns and global rate conditions.
Important for understanding transmission of global interest rate changes to domestic policy and reserves management; connects to forex reserves composition, external debt currency composition and implications for exchange rate and monetary policy responses.
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2.15 RBI's sources of Income and Economic Capital Framework > p. 76
- Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 16: Balance of Payments > 16.18 Indian Economy > p. 486
OMO are direct purchases and sales of government bonds by RBI that change bond demand, liquidity and hence yields.
High-yield for UPSC because OMO connects monetary policy to government debt markets; it links to questions on liquidity management, bond yields, and fiscal-monetary interaction. Mastering OMO helps answer policy-effect questions and explain short- to medium-term interest rate movements.
- Macroeconomics (NCERT class XII 2025 ed.) > Chapter 3: Money and Banking > 3.4 POLICY TOOLS TO CONTROL MONEY SUPPLY > p. 42
Repo/reverse repo operations and the bank rate are primary RBI tools that alter short-term interest rates and banking liquidity, affecting bond yields.
Important for explaining transmission of monetary policy into market interest rates and government securities yields; connects to banking liquidity, inflation control, and monetary transmission questions frequently asked in UPSC.
- Macroeconomics (NCERT class XII 2025 ed.) > Chapter 3: Money and Banking > 3.4 POLICY TOOLS TO CONTROL MONEY SUPPLY > p. 43
RBI acts as debt manager and conducts OMO, placing it at the interface of government borrowing and bond-market operations that determine yields.
Useful for questions on institutional roles, fiscal-monetary coordination, and how government borrowing conditions interact with central bank operations; enables answers on causes of yield changes and policy levers.
- Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2.15 RBI's sources of Income and Economic Capital Framework > p. 76
Inflation reduces the real value of fixed nominal interest and principal, harming bond holders and altering bond valuations.
High-yield for UPSC because it explains why nominal yields move with inflation expectations and informs questions on debt sustainability, investor distributional effects, and interest-rate policy. Connects to topics on public debt, real vs nominal interest rates, and fiscal cost of borrowing; useful for application and cause-effect questions.
- Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 4: Inflation > EFFECTS/IMPACT OF INFLATION > p. 70
The Yield Curve Inversion. Since UPSC asked about factors influencing yields, the next logical step is the *shape* of the yield curve. Specifically, when short-term yields exceed long-term yields, it historically predicts a Recession. Also, look out for 'Green Bonds' and 'Sovereign Gold Bonds' mechanics.
The 'Butterfly Effect' Heuristic. In a globalized economy, asking if the US Federal Reserve affects Indian markets is like asking if the Sun affects the Earth's temperature. The answer is almost always YES. In Economics 'influence' questions, unless the factor is absurd (e.g., 'Population of Penguins'), broad macroeconomic variables (Inflation, Fed, RBI) are always correct.
Mains GS-3 (Fiscal Policy): High bond yields directly increase the Government's borrowing cost (Interest Payments), which bloats the Revenue Deficit. This forces the Govt to borrow more, leading to a 'Debt Trap' and 'Crowding Out' of private investment.
SIMILAR QUESTIONS
Which of the following are the sources of income for the Reserve Bank of India? I. Buying and selling Government bonds II. Buying and selling foreign currency III. Pension fund management IV. Lending to private companies V. Printing and distributing currency notes Select the correct answer using the code given below.