Summary of this article
Bank of Japan raised policy rates to most in three decades
Japanese bond yields have also touched decade highs
Here's how Indian bonds will be impacted by the rising rates in Japan
The Bank of Japan raised its key policy rate to 0.75 per cent, the highest in 30 years. This comes on the back of rising inflation in the country despite the shrinking of the economy.
Japanese bond yields have also touched multi-year highs, with the 10-year benchmark Japan bond yield rising to 2 per cent, the most seen in nearly two decades. This is due to renewed fiscal concerns as well as expectations that more rate hikes could be on the way.
The decision of Japan’s central bank came after the change in leadership in the country earlier this year. Japan’s Prime Minister Sanae Takaichi is seen as willing to tolerate a monetary tightening cycle.
Japan had kept interest rates around or below zero for years due to deflationary pressures, even as most central banks around the world raised interest rates. The hiking cycle was sharper after the Covid-19 pandemic. But with rising inflationary pressures, Japan was also forced to raise its interest rates.
Additionally, a persistent weakness in the yen also added to pressure for the central bank to hike interest rates in an attempt to strengthen the currency. A rise in interest rates also makes it more attractive for global investors to invest in the market, for those looking for better returns in yen-denominated assets.
How global interest rates affect Indian bonds
For global investors, interest rate differentials of assets of different countries decide funding sentiments. For decades, due to lower rates in Japan, investors would fund their investments from the country at lower borrowing costs and park their investments in countries with higher yields, such as in emerging markets. This was also known as the yen carry-forward trade.
However, with the rise in borrowing rates in Japan, investors could unwind their trades to repay loans in Japan. Experts say this could lead to capital outflows from India, especially what is considered “hot money” from active investors. This is also due to the ongoing rate-easing cycle in India, which has reduced the interest rate differential between Japanese and Indian bonds, making it less attractive for global investors to put their money in Indian markets.
“Since the Bank of Japan has raised interest rates to 0.75% we expect that the unwinding of the yen carry trade could trigger more volatility as global investors would be forced to sell emerging market assets to repay increasingly expensive yen-denominated loans,” Abhishek Kumar, a Securities and Exchange Board of India (Sebi)-registered investment advisor (RIA), explained.
“This shift could drive Foreign Portfolio Investor (FPI) outflows from India to repatriate capital back to Japan to capitalise on higher domestic yields or cover rising borrowing costs,” Kumar said.
Meanwhile, passive investments into Indian bond markets are expected to continue into Indian bonds, especially with expectations that Indian bonds could be included in a few global market indices, market participants said.
