India US G-sec Yield Spread shrinks lowest in 2 decades, but yet cards in the favour of our economy

The yield spread (interest rate difference) between domestic and US Government bonds has reached its lowest levels in last 18-20 years. Theoretically, this should drive foreign capital out of India since the arbitrage or incentive to invest in India would be less favourable. However, overseas investors are not inclined to turn away from the world's fastest-growing major economy yet.

What could be the reasons for this textbook defying phenomenon?

In the words of Ashima Goyal, member of RBI MPC, “Despite narrower differentials, ECBs and other debt inflows continue. More than higher Indian rates it is the lower country risk, a stable currency and higher expected growth that keeps FPI here”

Inclusion of Indian G-secs in Bloomberg and JP Morgan’s Emerging Market Index has put Indian Bonds on a global map.

India’s external sector vulnerability metrics have only improved more favorably than ever in last 1 decade.

Exports of services are on the rise, and current deficit remains less than 2% of GDP. These factors are contributing positively to the Indian economy, despite the increasing crude oil prices.