Certain developments in the US economy could have positive spillover effects on a specific segment of the Indian economy-bonds. Given the economic trends in the world’s largest economy, capital flows from the US into India are not only likely but expected to remain consistent, aside from occasional short-term fluctuations.
Also, there are ways and avenues for the Indian investor to benefit from the seemingly unrelated economic decisions in the USA.
The US Federal Reserve, in its latest policy, went ahead with a third rate cut in a row. The policy remained balanced, with weaker labour market conditions being the main rationale behind the policy decision. According to the Bank of Baroda (BoB), there is limited scope for further easing in CY26, with just one rate cut priced in by the Fed.
So, what does this policy mean for India?
It becomes crucial from the standpoint of the interest rate differential between India and the US at a time when the rupee volatility has increased. The policy rate differential between India and the US has largely been contained due to the sharper pace of rate cuts by the RBI compared to the US. The yield differential has also mirrored the same trend, thus supporting FPI flows in the initial months. However, the recent volatility of the rupee has had an impact on flows of late.
Going forward, BoB expects the policy rate differential between India and the US to be maintained at the current level.
“FPI flows would evaluate the interest rate differential continuously along with the rupee movement while taking a decision,” says Madan Sabnavis, Chief Economist, BoB. For these institutions, rupee volatility is a negative (the cost of operations may increase), while a trade deal (between the US and India) may be a positive.
“The US Fed is clearly in an easing phase, but it’s not a fast or aggressive one. Think of it as slow relief, not a stimulus bazooka. Rates are coming down, but they will stay relatively high for longer,” says Nikunj Saraf, CEO, Choice Wealth.
For India, this is actually a comfortable zone.
As long as India’s growth engine stays strong and inflation behaves, foreign investors continue to earn well for holding Indian debt. In short, the Fed isn’t taking away India’s yield advantage anytime soon.
With Indian bond yields remaining relatively elevated and US Treasury yields stabilising, the interest rate differential is expected to stay favourable.
Structural changes in FPI inflows
There are also some structural changes in the current inflows into Indian bonds vis-à-vis previous flows. “This cycle is different from earlier ones, as FPIs are no longer coming only for short-term carry trades,” says Saraf.
India’s inclusion in global bond indices has changed the game, as passive index-linked flows continue even during short-term volatility. These flows don’t react to every global wobble, and even when the volatility spikes, index money keeps coming.
Monthly numbers may look choppy because of currency swings, but the medium-term trend is positive. As long as the rupee doesn’t look unstable and yields don’t collapse, India remains a steady allocation in global bond portfolios, as per experts.
Sabnavis notes that if there is a further rate cut in the US and bond yields (there) fall, this would translate into higher inflows into the debt segment in India.
Lower US yields reduce the global ‘risk-free’ return, nudging investors toward emerging markets. Flows only reverse sharply when rate cuts signal panic-like a recession or financial stress. That’s not the current backdrop.
If additional cuts also weaken the dollar, that’s actually a bonus for India. A softer dollar eases pressure on the rupee and improves total returns for foreign investors in Indian bonds.
Which bonds could attract FPI inflows?
Sabnavis notes that FPI flows into Indian bonds are not sector-specific, unlike equities, and are instead driven by the bond’s credit rating and liquidity.
Steady foreign investment gradually lowers yields, particularly in government securities where index buying is concentrated. This improves liquidity, smoothens trading, and reduces risk premiums, indirectly helping corporates borrow at lower costs. However, it’s a slow structural improvement, not a one-day rally.
Saini notes that there are three categories of investments (in the bonds universe), namely Corporate Bonds, SDLs (state development loans) and Government Securities. G-Secs offer better attractiveness compared to SDLs due to liquidity, lower credit risk and thus offer greater comfort to foreign investors, he says.
Elevated corporate borrowing can create attractive entry points for corporate bonds, offering yield enhancement without excessive credit risk.
“Sustained FPI inflows into the Indian bond market would have a softening impact on yields,” says Saini. As foreign investors increase/diversify their allocation, demand for government securities and high-yield bonds rises, leading to higher bond prices and consequently, lower yields. This effect, however, is also influenced by other factors like RBI liquidity policy, inflation trajectory, and government borrowing.
There are takeaways in FPI flows into Indian bonds for the retail investor, too.
Retail investors don’t need to track every Fed meeting or FPI flow chart, says Saraf. The smarter move is to stay aligned with where the big money is structurally headed. “Target-maturity and roll-down funds focused on government securities can benefit from stable yields and gradual compression. Gilt and constant-maturity funds gain if the mid-curve richens due to foreign demand,” he says.
High-quality corporate bond funds also stand to benefit as spreads tighten in a more liquid market, he says, adding that the idea is simple: ride the structure, not the noise.
Risks
“The biggest risk isn’t one fewer Fed cut. It’s a combination of global shocks-resurgent US inflation, a sharply stronger dollar, or a sudden spike in risk aversion,” says Saraf. On the domestic side, fiscal discipline and inflation control matter far more than overseas policy tweaks. Any slip there would hurt sentiment faster than a Fed dot-plot change.