Bond Yields Matter For India's Stock Market | The Reason Why

Global bond yields have been touching multi-year highs for the past few months. That has become a cause for concern for governments across many rich countries. Indian government bond yields too are rising. But that is not grabbing headlines. I argue that this is a cause for concern, and it is also impacting Indian equities. Let's dive deeper.

Impact of US Yields on India

The US 10‑year Treasury yield has climbed about 70 basis points (bps) this year, while the Indian counterpart has risen only around 40 bps. One hundred basis points means one percentage point. Today they are trading near 4.9% in the US and 6.9% in India.

At the end of 2023, India offered a yield advantage of roughly 3.3 percentage points (ppt) over the US. Today that gap is a little above 2 ppts. We see a similar trend in the real (or inflation-adjusted) yield as well. In simple terms, the extra income investors once earned by choosing Indian bonds over the US Treasuries has shrunk.

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This matters because investment in India comes with emerging market (EM) risk, currency volatility and higher hedging costs. For many global investors, a small advantage of a few percentage points is not enough to justify taking on rupee risk and broader EM uncertainty.

Structure of Indian Bond Market

India's government bond market has a big, steady domestic buyer base. Banks, insurance companies, pension funds and provident funds are all required to hold government and approved securities. So they end up owning most of the market. As of March 2026, these institutions held about two‑thirds of all central government bonds. The RBI held another 18%, while foreign investors owned only around 3%.

Because of this structure, India doesn't rely much on foreign money to fund its bond market. That helps explain why global bond market shocks do not pass through to Indian yields one-for-one. Domestic buyers keep purchasing. That was one of the major arguments in a recent piece in The Economist. 

But this doesn't mean Indian yields are insulated. When the government borrows more, it has to issue more bonds. If supply rises faster than demand, yields move up. 

The RBI studied this and found a clear pattern: a 1% increase in bond supply tends to push long‑term yields up by roughly 9.5-10 bps. That's why fiscal policy matters to bond yields, alongside global yields, inflation and liquidity.

How Bond Yields Impact Indian Equities?

Global yield shocks spill over into equities too. When the US 10‑year heads toward 5%, the discount rate used to value future earnings rises everywhere. For India, that matters more because valuations are already on the higher side.

The Nifty's trailing PE of about 19.9x translates into an earnings yield of roughly 5%. Earnings yield is the inverse of the PE ratio. It tells you how much return the market is giving you for every rupee of earnings today. That 5% is lower than the ~7% available on Indian government bonds. In other words, bonds pay more than the earnings yield on equities. So equities need to offer a strong reason, mainly future earnings growth, to justify taking on more risk.

The gap between the earnings yield and the risk‑free rate is the equity risk premium (ERP). At the end of 2023, it was close to -3 ppts. Today it has improved to about -2 ppts, but it's still negative. Much of that improvement has come from price correction in recent quarters.

How Can Equity Risk Premium Improve?

Whether the ERP can improve from here comes down to two things: earnings growth and fiscal discipline.

Start with earnings. In Q1 FY27, Nifty-50 profit after tax grew 18%, its strongest growth in ten quarters. In Motilal Oswal's broader universe, excluding oil marketing companies, sales were up 18%, EBITDA rose 15%, and PAT jumped 22%. Nineteen sectors beat expectations. Early Q2 forecasts still point to healthy earnings growth, although higher input costs could put pressure on margins. 

When earnings grow faster than prices, valuations cool naturally. The PE compresses, the earnings yield rises, and the ERP improves without a market correction.

Fiscal policy matters too. If the government keeps the deficit in check, borrowing stays contained and long‑term yields can drift lower. Even a small decline in the 10‑year G‑Sec yield narrows the gap between the earnings yield and the risk‑free rate. That alone can lift the ERP, again without forcing equity valuations to fall.

That is the healthiest path forward. But it depends on inflation remaining contained.

Sources: RBI, Federal Reserve, Investing.com, World PE Ratios, NSE, Reuters, and Cleveland Fed. Note: Real yields = Nominal yields - Consumer Price Index. CPI for December 2023 and professional forecasts for August 2026 were used for the above calculation.

Inflation Pressures Don't Go Away

Inflation will always hang around like an uninvited guest. The headline numbers look calm, but the underlying pressures haven't gone away. 

The biggest sources of inflation have been the weak rupee and oil prices. A weaker rupee makes crude more expensive. Higher fuel costs add up quickly in transportation costs. Climate change adds another layer. As rainfall has become more erratic, pockets of the country have already seen shortages and price rises in foodgrains and other essentials.

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These disruptions feed slowly into national prices but can hit hard because food carries the highest weight in the inflation basket.

When households and businesses expect prices to rise, interest rates tend to stay higher. And if CPI moves above 6%, the central bank may have to turn hawkish again. In such times, the government may have to subsidise food and fuel, adding more pressure to the fiscal deficit. Together, it all raises interest rates and yields.

Final Take

Over the next year, the path for Indian markets will depend on how these pieces fit together. If fiscal policy stays disciplined and earnings growth remains strong, long-term yields can ease without destabilising the currency. The combination of lower borrowing, softer yields and rising profits would lift the equity risk premium and make Indian assets more attractive. But nothing in macroeconomics is guaranteed, or without unintended consequences.

Disclaimer: The views expressed in this article are solely those of the author and do not necessarily reflect the opinion of NDTV Profit or its affiliates. Readers are advised to conduct their own research or consult a qualified professional before making any investment or business decisions. NDTV Profit does not guarantee the accuracy, completeness, or reliability of the information presented in this article.

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