Adding to the sudden reversal in foreign buying interest in bonds is the rise in crude oil prices over the past few weeks due to concerns of tighter supply and a recent flare-up in Middle East tensions. A higher trajectory for crude oil prices imparts uncertainty to the outlook on India’s inflation and trade deficit.
“The cocktail of rising oil prices, strong dollar and repricing of Fed’s path leading to higher US yields is behind the debt selloff in India… since index-inclusion related passive flows will only begin in June, till then, the reactions of the ‘front-runners’ and BAU (business as usual) investors will continue to dominate,” said Dhiraj Nim, FX strategist at ANZ.
From March 21 to April 16, FPI holdings of Fully Accessible Route (FAR) government bonds have declined by ₹9,873.71 crore to ₹1.66 lakh crore, latest data released by the Clearing Corporation of India showed. FPI holdings of FAR government bonds had increased from ₹94,416.14 crore as on September 21 to ₹1.77 lakh crore as on March 21. On September 21, JP Morgan had announced inclusion of Indian bonds in its emerging market bond index from June 2024, sparking a rush amongst foreigners to stock up on local debt, especially those looking to reap quick price gains.
According to Arete Capital’s vice-president Mataprasad Pandey, FPIs had brought down short-term bond holdings and moved towards longer-duration debt, suggesting a trading strategy that hinges on capital appreciation as and when the RBI cuts rates. Yield on the 10-year US bond climbed 30 basis points from March 21 to April 16, while crude prices have gained more than 15% so far in 2024, Reuters reported. Meanwhile, the rupee has touched new lows versus the US dollar, breaching the 83.50/$1 mark, although the decline in the local currency has been more contained than peer currencies.Higher US bond yields typically lead to outflows of foreign investment from emerging market fixed-income assets to bonds in the world’s largest economy. Further, a weaker rupee eats into FPIs’ returns from Indian bonds. From March 21 to April 16, yield on the domestic 10-year benchmark bond rose 14 basis points. Bond prices and yields move inversely.Since Indian bonds were included in global indices, RBI Governor Shaktikanta Das has referred to foreign inflows as a double-edged weapon, pointing that if there inflows there could be outflows too. While short-term trading calls by some categories of foreign players such as hedge funds have the potential to impart volatility, analysts broadly believe the index-related flows would be more stable than not.