Japan’s rate hike could send another shockwave through Indian markets

Article Summary

• The Bank of Japan is expected to raise rates to 1.25% on September 18, potentially accelerating the unwinding of the yen carry trade.
• Higher Japanese yields could encourage global investors to repatriate capital, putting pressure on Indian equities and the rupee.
• Indian companies with yen-denominated borrowing could face higher repayment costs if the yen strengthens.
• The impact may be particularly uncomfortable for India at a time when its markets are already dealing with foreign outflows, expensive oil, and global risk aversion.

For years, one of the world’s most important financial bargains was hiding in plain sight: borrow cheaply in Japan and put the money to work somewhere offering better returns.

That trade is now getting harder. The Bank of Japan is expected to raise its policy rate by 25 basis points to 1.25% on September 18, according to Reuters. More importantly for global markets, expectations are building that Japanese rates could continue rising, with the same poll pointing to a possible 1.75% rate by the second quarter of 2027.

For India, the immediate concern is less about what a 25-basis-point move does to the Japanese economy and more about what it does to global money flows.

The yen carry trade starts to lose its appeal

The yen has traditionally been one of the world’s favourite funding currencies because Japanese interest rates remained exceptionally low for decades. Investors could borrow in yen at relatively cheap rates, convert that money into other currencies, and invest in assets offering higher returns, including emerging-market equities and bonds.

India has been one of the destinations for this global search for yield, but a Japanese rate hike changes the calculation. Borrowing in yen becomes more expensive, while a stronger yen can increase the cost of repaying those loans. Investors who have borrowed yen to finance investments elsewhere therefore have an additional reason to close their positions.

That means selling assets, buying yen, and repaying yen-denominated debt. The mechanics can become self-reinforcing. As investors sell overseas assets and buy yen, the yen strengthens. A stronger yen makes existing carry trades even more expensive to unwind, creating further pressure to exit.

The yen has already strengthened sharply amid expectations of BOJ tightening, with Reuters reporting that it gained nearly 5% in the space of a week as investors unwound carry positions and considered repatriating overseas funds.

India could feel the selling pressure

India’s vulnerability comes from the sheer importance of foreign capital to its markets. When Japanese government bond yields become more attractive, investors do not necessarily have to take significant emerging-market risk to earn a return. Money can move back towards Japanese assets, particularly if the yen is also expected to appreciate.

That creates a second channel of pressure: foreign portfolio outflows. India is already entering this phase from a position of relative weakness. The Sensex has fallen roughly 12% since the beginning of 2026, according to the Indian Express, while foreign investors have been selling Indian equities amid concerns over global yields, oil prices, and geopolitical risks.

The BOJ decision could therefore arrive at an uncomfortable time. If Japanese investors and global funds simultaneously reduce exposure to riskier markets, Indian equities could face another bout of selling.

The pain is unlikely to be distributed evenly. High-beta stocks, richly valued companies, and mid- and small-caps are generally more vulnerable when liquidity tightens and foreign investors become risk-averse.

Indian companies could also feel the yen

There is a more direct corporate impact. Indian companies that have borrowed in yen through external commercial borrowings can face higher repayment costs if the Japanese currency appreciates. The problem is particularly relevant because a yen-denominated loan has two components: the interest cost and the exchange rate at which the principal and interest ultimately have to be serviced.

A stronger yen can therefore turn a previously attractive borrowing arrangement into a more expensive liability. India’s corporate appetite for overseas borrowing has also been strong. Companies submitted proposals for $7.70 billion of external commercial borrowings in July, according to RBI data reported by the Economic Times.

The bigger question is what happens after September 18

A single 25-basis-point hike does not automatically mean an Indian market meltdown. Much of the move has already been anticipated by investors.

The greater risk lies in what Bank of Japan Governor Kazuo Ueda signals afterwards. If September 18 marks the beginning of a faster tightening cycle, rather than an isolated move, the world could have to adjust to a fundamental change in the global cost of money.

That matters for India because the country is already dealing with elevated oil prices, a weaker rupee, high global bond yields, and foreign selling. On September 11, the Nifty fell around 1% as Brent crude moved above $108 a barrel and the US 10-year yield approached 5%.

India’s domestic fundamentals may remain relatively strong, but markets are rarely driven by fundamentals alone. Liquidity matters too. For years, cheap Japanese money helped lubricate global risk-taking. As Japan finally moves towards a more normal interest-rate regime, some of that liquidity may begin flowing home.

For Indian investors, September 18 is therefore worth watching closely. The real question is not simply whether Japan raises rates. It is how much of the world’s borrowed yen comes home afterwards.