The recent slowing of foreign investment in so-called fully accessible government bonds has caught the attention of the Reserve Bank of India (RBI), which has been making market enquiries about the impact of global volatility on local debt markets amid pressure on the rupee’s exchange rate.
Officials from RBI’s Financial Markets Regulation Department (FMRD) have informally spoken to banks, particularly foreign lenders, to gauge unwinding of overseas trading positions in Indian debt markets, including those taken in certain interest rate derivatives, people aware of the matter told ET.
“FMRD officials makes regular calls to bond market participants to assess market developments and over the last couple of days focus has been on outflows from the FAR (fully accessible route) securities at a time when heavy equity outflows due to global turmoil have exerted pressure on rupee,” a source said.
TRS Positions of Banks
“They have been asking foreign banks about the unwinding of TRS (total return swap) positions as a portion of the flows that hit the market in the run-up to the JP Morgan index inclusion were via the TRS instrument, which is used as a proxy to take exposure to local bonds,” the person said.
The FAR category of government securities, introduced by the RBI in March 2020, has no restrictions on overseas investment. Only bonds in the FAR category are eligible for inclusion in the JP Morgan index.
Of around $10 billion worth of foreign investment that flowed into Indian debt from September 2023 to June 2024, foreign bankers estimated 20-25% to be through TRS instruments. JP Morgan announced India’s inclusion in its EM bond index in September 2023. The RBI didn’t respond to queries.
BONDS LOSE APPEAL
After three months of heavy foreign portfolio investment flows into Indian FAR bonds, the pace of overseas buying has come to an abrupt halt this month, with last week marking the first weekly outflow since domestic bonds were included in the JP Morgan index on June 28. Meanwhile, foreign portfolio investors (FPI) have sold local stocks worth $8 billion so far this month, depository data showed.
In the week ended October 11, the indicative value of aggregate holding of FPIs in FAR bonds dropped by ₹1,675.25 crore to ₹2.48 lakh crore, Clearing Corporation of India data showed. Between September 30 and October 15, FPI holdings of FAR bonds have increased by just ₹47.5 crore, a much smaller rise than in the preceding three months. On October 15, the FPI holding of FAR bonds was at ₹2.47 lakh crore.
In July, the value of FPI holdings in FAR bonds rose by ₹21,033 crore, followed by an increase of ₹23,914 crore in August and ₹17,971 crore in September, the data showed.
If the monthly FPI flows in FA R bonds are to match the rate of $2.0-2.5 billion in the last three months, the pace of investment would need to dramatically increase over the 11 trading days remaining in October.
“There were heavy discretionary flows that happened in the run-up to index inclusion,” said an expert. “Market participants have communicated to the RBI that given the surge in US bond yields this month and the volatility in oil prices, it is possible that some of the discretionary overweight positions are being unwound.”
The waning FPI interest stems from unfavourable global factors, including reduced expectations of US rate cuts, sharp volatility in crude oil prices amid escalating violence in West Asia and market swings triggered by China’s efforts to bolster its ailing economy.
On Friday, the rupee weakened past the psychologically significant 84 per dollar mark for the first time in the onshore market as international headwinds sparked a global rush towar d the safety of the US currency.
Also, stronger-than-expected US data have led global investors to tone down earlier expectations of aggressive rate cuts by the Federal Reserve in coming months. This has pushed up 10 -year US treasury yields by a substantial 22 basis points so far this month. Higher US bond yields reduce the appeal of fixed-income assets in emerging markets like India.
While overseas flows in FAR bonds have slowed this month, some degree of recovery could take place by the end of the month, given that India’s weight in the JP Morgan index is designed to rise by 1% each month till March 2025.
