MUMBAI: Foreign portfolio investors (FPIs) stepped up their exit from Indian government bonds in September as surging US Treasury yields and geopolitical uncertainty eroded the relative appeal of domestic debt.
FPIs sold a net Rs 10,602 crore of government securities under the fully accessible route (FAR) during September, the highest outflow in six months, data from the Clearing Corporation of India showed. This compares with net selling of just Rs 846 crore in August and marks a reversal after four months of strong buying following the government’s tax concessions for overseas investors.
At the heart of the shift is the rapidly narrowing yield differential between India and the US.
The US 10-year Treasury yield has climbed to around 5.24%, near a two-decade high, amid inflationary pressures and concerns over the country’s fiscal position. With India’s benchmark 10-year government bond ending at 7.19% on Wednesday, the spread between the two has shrunk to about 195 basis points from 272 basis points at the end of March.
“With global sentiment and higher global yields, the attractiveness of different asset classes plays a role in FPI decision-making. With US 10-year yields now near 5.25%, foreign portfolio and real-money investors have a stronger incentive to shift into US bonds,” said a treasury official at a foreign bank.
The narrowing spread means overseas investors are getting progressively less additional yield for taking exposure to Indian bonds. At the same time, heightened geopolitical risks have strengthened the appeal of US Treasuries as a safe-haven asset.
India’s dependence on imported crude oil and its extensive trade links with the Middle East could also make domestic assets more vulnerable to a prolonged risk-off environment, the treasury official said.
The reversal comes barely three months after FPIs had piled into government securities following a series of measures aimed at attracting foreign capital.
The government exempted interest income and capital gains on foreign investments in sovereign debt from tax, while the Reserve Bank of India expanded the FAR universe to include 15-, 30- and 40-year government bonds.
The measures triggered a sharp surge in foreign buying, with net purchases touching Rs 41,773 crore in June. The momentum, however, faded quickly, with purchases moderating to Rs 7,581 crore in July before FPIs turned net sellers.
“Rising global yields have made the environment more challenging for India. One key reason why inflows into India have dried up is the significantly higher global cost of capital and tighter availability of funds,” said Dhiraj Nim, economist and FX strategist at ANZ Bank.
The deferment of India’s inclusion in Bloomberg’s global bond indices has added to the pressure. Bloomberg Index Services in late July postponed the inclusion, saying more time was needed for recent market reforms to become fully embedded in trading and operational practices.
Market participants said some of the foreign buying in the preceding months may have reflected investors positioning themselves ahead of the anticipated index inclusion. Its postponement removed another potential trigger for overseas flows.
“Debt inflows seen in July and August were likely driven by pre-positioning ahead of expected index inclusion. With that not materialising and global yields continuing to rise, inflows into debt are likely to remain difficult,” Nim said.
With US yields remaining elevated and the India-US yield differential narrowing sharply, market participants expect the external environment to remain a key constraint on fresh FPI demand for government bonds.
Source: The Financial Express
