What is the issue?
- After a strong 6% appreciation against the ‘US Dollar’ in 2017, Rupee value has depreciated by about 4.5% thus far in 2018.
- The present slide is on account of rising oil prices and increasing yield significant FII (Foreign institutional Investors) outflows.
Why are FII’s pulling out?
- The increased demand for US Dollar is nudging out FIIs to pull out from Indian stock markets and move to destinations of better returns.
- While as much as $30 billion was pumped into Indian debt and equity in 2017 by FIIs, they’ve currently pulled out a net of $2.3 billion in March alone.
- US Federal Reserve has signalled last month that it is on course to raise the policy rate at least two more times in 2018 (curtailment of Dollar supply).
- This has also fed into investor expectations, and precipitated in a 3% rise of yield for 10 year benchmark US Treasury bonds, for the 1st time since 2014.
What are the trends in global oil prices?
- Global oil prices are continuing a steady climb on the back of tight output controls marshalled by the OPEC.
- Notably, Saudi Arabia, the world’s largest oil producer, has stated that it is eyeing oil prices in the vicinity of $80 a barrel to meets its budgetary demands.
- Tensions between Iran and US over the Nuclear Deal pullout would also most certainly prevent any softening of oil prices.
- Even a possible increase in US shale oil output has been estimated to be insufficient to offset the expected price spike.
What are the possible impacts for Indian Rupee?
- Rupee is particularly vulnerable to mounting oil costs given the economy’s extremely high dependence on crude imports to meet energy needs.
- Increase in oil prices has bloated India’s crude import bill and widened the trade deficit, which for March 2018 alone was about $13.69 billion.
- Additionally, the pullout of FII’s has also increased rupee supply in the international currency market.
- All these factors has led to considerable depreciation, which needs to be moderated in order to ease the pressure on import bills.
- In this backdrop, RBI’s massive $423.6 billion in forex reserves does provides some respite, as this might help in dampening Rupee volatility.
The Bond Market Concept
What does Bonds Yield mean?
- Bonds are loan instruments and hence are a safer and “Bond Yield” is the percentage of return that an investor in bonds derives per annum.
- Let us consider a bond (that is issued by a borrower) at a face value of Rs.1000, with a rate of interest of 10% on the Face Value.
- For the initial investor, the bond yields Rs.100 for his investment of Rs. 1000, which implies his yield is 10%.
- When bonds are sold in the secondary market, bond yield for subsequent investor might vary depending on the sale price (Real Bond Value).
- But irrespective of the Real Bond Value, interest rates are always based on the ‘Face Value’ as determined by the primary borrower.
- If Real Bond Value (sale price) increases over time, then bond yield decreases, as the interest amount will remain the same despite a higher investment.
- Conversely, if Real Bond Value decreases, then yield increases as a lower sum would be able to get the same interest amount.
- Hence, Bond Yield and Bond Value hold an inverse relation.
What factors influence Bond Yield?
- Market interest rates (banks) are the primary influencers of Bond markets as they are competing investment options for people.
- An increase in interest rates would reduce the demand for low yielding bonds as people would want to put their money where returns are higher.
- To sell Bonds when market rates are high, a Bond holder will have to ‘lower his/her bond value’ to ‘increase bond yield and attract investors’.
- It is to be noted that money is in demand when market interest rates are high.
- Currently, this is what is happening in the US Economy as the US Federal Reserves has increased interest rates and pledged further increases.
- Conversely, a decrease in market interest rates would make bonds attractive for investment and hence lead to a spike in Bond Value due to demand.
- Also, Bonds are a safer investment option than others, and hence any economic uncertainty would drive investors to buy bonds.
- These factors would create a spike in bond demand, which would thereby increase Bond Value and reduce Bond Yield.
Source: The Hindu
