Global capital is no longer cheap, that’s the challenge

Why in the News

Ten-year government bond yields in the United States (US) and France have hit 5.34% and 4.99%, their highest since 2002, and Japan’s has crossed 3.1% for the first time since 1996. Investors now demand higher returns even from rich-country governments, so India must plan for a world where global capital is no longer cheap.

What is a bond yield, and why does its rise matter?

1. What it is: A bond yield is the return investors demand for lending to a government through tradable debt. It works like the interest rate a lender charges a borrower.
2. Why it was seen as safe: Government bonds are treated as default risk-free, because a sovereign can tax and print currency to repay.
3. What changed: Borrowing costs for rich-country governments rose 1.2 to 1.4 percentage points in a year, roughly twice India’s rise.
4. No safe-haven discount: Investors now treat advanced and emerging economies as almost equally risky, and advanced-economy bond yields have surged to multi-decade peaks.
5. The takeaway: When even the safest borrowers pay more, every other borrower, India included, pays more for global money.

Why are rich-country borrowing costs rising?

1. Persistent deficits: Developed-country governments keep running deficits because of ageing populations, expanded welfare alongside military build-up, and voter resistance to higher taxes or entitlement cuts:
   • US public debt has crossed $40 trillion;
   • the US defence budget reached a record $1 trillion for 2026;
   • advanced economies paid over $3.3 trillion in interest last year, according to the Institute of International Finance (IIF);
   • China, wary of US fiscal risk, cut its holdings of US Treasuries (US government bonds) to an 18-year low of $618 billion in July 2026.
2. Commodity inflation: War and weather-driven supply shocks raise commodity prices, so central banks raise interest rates and signal more increases.
3. Artificial intelligence (AI) infrastructure race: The four hyperscalers (firms running giant cloud data centres), Meta, Microsoft, Amazon and Google, are funding much of their capital spending with debt. As technology firms borrow in bond markets, governments must compete harder for investors, which drives up yields even on “safe haven” long-term US Treasuries.

What does this mean for India?

1. Domestic yield: India’s 10-year government security (G-sec) yield rose 0.7 percentage points in a year and closed the week at 7.21%.
2. Costlier foreign capital: Policymakers and corporates must accept that cheap global capital is no longer available for borrowing or investment plans.
3. Fiscal discipline: Heavy government borrowing at home pushes up interest rates and leaves less credit for private firms. This is crowding out, so restraint matters for India too.

Challenges

1. Portfolio outflows: Higher US yields pull foreign investors out of Indian bonds. Eg. Net foreign portfolio outflows pressured the rupee in 2025.
2. Large borrowing programme: The Centre still plans heavy market borrowing, competing with firms for domestic savings.
3. Imported inflation: Commodity shocks raise India’s import bill, so interest rate cuts get delayed.
4. Corporate foreign debt: Firms with unhedged foreign currency loans, meaning loans not protected against currency swings, face higher refinancing costs.

Way Forward

1. Debt anchor: The Centre should hold to its path of cutting debt to about 50% of GDP by March 2031.
2. Quality of spending: Shift borrowing toward capital expenditure rather than revenue spending.
3. Deeper bond market: The Reserve Bank of India should widen the domestic investor base for long-term G-secs.
4. Currency hedging: Regulators should push corporates to hedge external commercial borrowings (loans raised abroad).

Conclusion

A world of costlier capital punishes fiscal slippage faster than before, and emerging economies have less room than rich ones to absorb it. Whether India keeps its borrowing in check as advanced-economy deficits and AI-driven debt keep rising is what will set its cost of capital.

Key numbers

1. Chinese holdings of US Treasuries, peak: $1.32 trillion, November 2013.
2. Proposed US defence budget: $1.5 trillion for the coming fiscal year.
3. Hyperscaler capital spending: $410 billion (2025), $725 billion projected (2026), over $1.1 trillion (2027).

Back2Basics: Government security (G-sec)

1. What it is: A G-sec is a tradable debt instrument issued by the Central or a State government, acknowledging its debt.
2. Types: Short-term Treasury Bills mature in under one year; dated securities run for one year or more.
3. Who manages it: The Reserve Bank of India issues and manages G-secs on the government’s behalf.
4. Why its yield matters: The 10-year G-sec yield is the benchmark against which other long-term loans in the economy are priced.

Matching Previous Year Question

“[2026] Which one of the following best describes the ‘Crowding Out Effect’ in the context of fiscal policy? (a) A situation where private investment increases due to increased Government spending (b) A situation where Government borrowing leads to higher interest rates, which reduces private investment (c) A situation where an increase in taxes leads to increased private sector investment (d) A situation where Government spending has no impact on aggregate demand Answer: B”