As the US grapples with significant fiscal decisions, the ripple effects are likely to be felt across global financial markets—including in India. Vikram Chhabra, Senior Economist, 360 ONE Asset explores how the recent US tax bill, evolving bond yield trends, and potential slowdown in the US economy could shape policy responses and impact India.

The US tax bill is expected to add approximately ~$3.1 trillion1 to the US national debt over the next decade. This comes against the backdrop of an already deteriorating fiscal position, with the US running a sizeable fiscal deficit of around 6%2. The rising debt burden has already prompted Moody’s to downgrade the US credit rating.

This challenging fiscal trajectory further complicates the Federal Reserve’s policy outlook. With economic policy uncertainty heightened by tariffs and trade tensions, the Fed is likely to maintain a cautious, wait-and-see approach in the near term. Over the longer term, however, such fiscal expansion could limit the central bank’s ability to loosen monetary policy significantly.

Bond yields in Japan and the US on the rise: will the trend continue?

A combination of factors is driving US bond yields higher, including a high fiscal deficit, the recent credit rating downgrade, erratic policymaking, and the Federal Reserve’s cautious stance. Additionally, the new tax bill is expected to add substantially to the national debt. Unless significant fiscal reforms are implemented to address the growing deficit, policymaking stabilises, and tariffs ease, US bond yields are likely to remain elevated.

In Japan, inflation is becoming more entrenched, with stronger-than-expected inflation data raising expectations of further tightening by the Bank of Japan and prompting markets to price in a higher terminal policy rate. Weaker bond auctions and recent remarks by the Prime Minister, hinting at fiscal concerns, have added to investor worries and pushed yields higher.

The increase in Japanese bond yields could have ripple effects on global markets, particularly the US Treasury market. As major holders of US debt, Japanese investors may shift investments toward domestic bonds, putting upward pressure on US yields.

Impact of a US slowdown on the Indian economy

A potential slowdown in the US economy could impact India’s merchandise exports, particularly in sectors such as electronics, gems and jewellery, textiles and apparel, pharmaceuticals, and capital goods. However, these exports to the US constitute only about 2%3 of India’s GDP, which is relatively low compared to other economies. Therefore, the overall impact on the Indian economy through the merchandise trade channel may be limited.

In contrast, India’s software services exports are likely to be significantly affected, as they are closely tied to the US economic growth. The US accounts for ~54%4 of India’s total software services exports. Consequently, a slowdown in the US could have a pronounced impact on India’s software services industry.

Source: 1Congressional Budget Office and CRFB estimates 2U.S. Office of Management and Budget 3US Census and IMF 4 RBI

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