Foreign investment in Indian bonds has held firm amid global headwinds that have roiled markets and prompted overseas players to sell local stocks. Going ahead, what will determine whether local bonds turn into overseas favourites or see some volatility is the reasons the Fed gives for ending its two-year long inflation battle.
If global financial futures contracts are anything to go by, the Federal Reserve is all set to cut interest rates next month, ushering in lower borrowing costs in the world’s largest economy.
Theoretically, this should translate into accelerated foreign flows into emerging market debt, but international banks – which play a major role in facilitating overseas investment in India – are waiting to see whether the Fed acts to ward off a growth slowdown or whether it provides a reassuring view on economic prospects.
“The important thing going ahead now is the reason why the Fed starts cutting rates. Historically, if the Fed starts cutting because of a soft landing, then typically Asian currencies do well. Whereas if the Fed is cutting in response to a domestic economic crisis, that sparks a global wave of risk aversion, resulting in dollar strength and weakness in Asian currencies,” said Nitin Agarwal, head of trading at ANZ.
“When it comes to the pace of flows into Indian bonds going ahead, what we will have to see is whether it’s a soft landing accompanied by gradual rate cuts from the Fed,” he said.
Counting June 28, the day Indian sovereign debt was included in a JP Morgan index, fully accessible local bonds have seen foreign investment worth $3.7 billion, with flows worth around $1.2 billion hitting the market so far this month, clearing house data showed. FPIs have sold local stocks worth $2.6 billion so far in August.
“The recession trade could pick up steam if there are further concerns over the US growth projections and unemployment and that could mean a risk-off scenario. This has historically led to EM debt sell-off and given the overweight positioning we might see some volatility in flows in INR debt also from FPIs,” said Aditya Bagree, head, markets, Citi – India & Indian subcontinent.
“However, given the Indian economy’s strong macro story, we do think the overall impact on INR and Indian bond yields will remain limited. We are currently looking at a market which is looking favourably at Indian debt due to several factors,” he said.
To be sure, local bonds are poised to corner a larger share of foreign flows if a much-awaited US ‘soft-landing’ were to materialize, given India’s resilient macroeconomic fundamentals, and the flurry of foreign interest directed towards local debt due to global bond index inclusion.
“We don’t expect any significant change in flow pattern from real money investors though we may see higher flows from fast money clients on the back of a positive outlook on the Indian currency. We continue to expect a flow of about USD 2.0 billion every month for next seven months,” said Vikas Jain, Head of India FICC Trading, Bank of America.
In early August, following the release of weaker-than-expected US employment numbers, speculation of a slowing US economy strengthened, bruising risk appetite and triggering foreign outflows from Indian stocks which pushed the rupee to a record low against the dollar.
While the rupee still continues to be amongst the most stable currencies in the region, the outlook on the local currency is a major factor that foreign money managers consider when choosing to deploy funds here
