Mumbai: Foreign funds have poured money into government bonds at a tearing pace over the past few months, with their investments in the fully accessible category more than doubling in a year to ₹1.28 lakh crore by December as global index inclusion and a softer tone from the US Fed burnish the appeal of Indian debt.
The influx of foreign money after a three-year hiatus has kept local sovereign bond yields – and therefore corporate borrowing costs – anchored amid a volatile inflation environment and a tight liquidity stance by the Reserve Bank of India (RBI).
The indicative value of aggregate holdings of foreign portfolio investors (FPIs) in government bonds under the ‘fully accessible route’ (FAR) was at ₹1.28 lakh crore as on December 26, versus ₹61,260 crore as on December 30, 2022, latest data released by the Clearing Corporation of India (CCIL) showed. The FAR category was introduced by the RBI in 2020.
“As we’ve seen in other jurisdictions also, a lot of money actually comes in before the index weighting starts to take effect. The second factor would be that global markets are now taking a view that the Fed is going to ease policy. To that extent, emerging markets have received renewed capital flows,” said Rajeev Radhakrishnan, chief investment officer, fixed income at SBI Mutual Fund.
From September 22 to December 26, the increase in FPI holdings of sovereign debt under the FAR category was at ₹33,243.07 crore, a rise which outstrips sales of government bonds worth ₹29,778 crore by overseas investors in the general category of Indian bonds from 2020 to now.
It was in September that JP Morgan announced the long-awaited inclusion of Indian government bonds in its emerging market index from June 2024, a move that is estimated to bring in inflows worth $20-$25 billion over the next couple of years.
Accounting for investments in corporate bonds, FPIs’ net purchases of Indian debt are at $8.2 billion so far in 2023, the highest since 2017, data released by the National Securities Depository showed. While yield on the 10-year benchmark government bond has tumbled 17 basis points since October, the future course of the pricing benchmark for a host of credit products hinges on the RBI’s approach to liquidity.
Given that the near-term inflation trajectory is likely to see an upward bias due to hardening food prices, the central bank is unlikely to loosen its grip on tight liquidity in the banking system anytime soon. The RBI, which has flagged the inflationary risks of excess liquidity, has been withdrawing monetary accommodation since April 2022.
Amid predictions of a gush of overseas funds into Indian debt next year, the Reserve Bank of India may be wary of benchmark bond yields heading lower while the central bank is still in an anti-inflationary mode and calling for greater transmission of past rate hikes.
The central bank in October had alluded to the use of open market sales of government bonds to drain out excess cash in the wake of a huge increase in liquidity after the return of ₹2,000 notes to banks.
Such bond sales are unlikely at the current juncture as headline liquidity in the banking system is at multi-year high deficit.
However, if capital flows were to accelerate sharply next year and inflation were not yet within the Reserve Bank of India comfort zone, the central bank could take steps on liquidity that would pull up bond yields.
