India may need to rely more on exports and long-term investment flows to fund its growth as the gap between Indian and US interest rates narrows, according to a comprehensive study by SBI Research. The report indicates that the country's traditional advantage of offering significantly higher returns than developed markets is shrinking, which could make it harder to attract the same scale of foreign capital used to finance current account deficits in the past. As reported by The Hindu BusinessLine, this shift represents a fundamental change in India's growth strategy away from heavy dependence on foreign capital inflows.
The research notes that India's economic fundamentals remain relatively stable, supported by anchored inflation, gradual fiscal consolidation and an improving sovereign credit profile. According to the SBI Research report, domestic interest rates are unlikely to rise as sharply as those in the US due to these strong fundamentals. However, a lower interest-rate differential could reduce the attractiveness of Indian debt for global investors, necessitating the strategic pivot toward export competitiveness.
The backdrop to this shift is a structural rise in US bond yields, with the era of ultra-low interest rates that followed the Global Financial Crisis appearing to be over. As reported by SBI Research, around 75-85 per cent of the increase in yields since 2020 has been driven by inflation and aggressive monetary tightening. The study argues that a more lasting increase in real interest rates is now underway, with factors such as persistent US government borrowing, increased Treasury issuance, productivity gains from artificial intelligence and gradual diversification away from dollar assets pushing up the US economy's natural rate of interest.
For India, the key implication is not necessarily higher borrowing costs but a change in external financing dynamics. According to the SBI Research report, with India's inflation premium over the US narrowing over the past decade, yield spreads between the two countries have compressed. The report specifically notes that the gap between inflation in India and the US had narrowed over the past decade, reducing the difference in policy rates and government bond yields between the two economies. In such an environment, large foreign capital inflows, previously crucial for financing the current account deficit, may become less dependable. To counter this challenge, the study suggests boosting export-led growth, encouraging foreign equity investments, and maintaining strong foreign exchange reserves to ensure currency stability. This represents a fundamental shift in how India finances its growth and trade balance.
