FPIs bet small on local debt, inflow pickup seen far away

Synopsis

April witnessed a slight inflow of foreign investments into Indian debt, but the atmosphere remains one of caution. Influences like escalating US and Japan interest rates, a weaker rupee, and fiscal uncertainties have created a challenging environment for investors. With the potential for continued outflows driven by oil prices, optimistic investment prospects appear dim in the short term.

Foreign portfolio investors were cautious on Indian debt in April, with returns weighed down by a combination of global and domestic headwinds. They invested a modest ₹1,976 crore through the fully accessible route (FAR) for eligible government securities during the month, following net sales of ₹17,688 crore in March.

Economists said elevated real interest rates in advanced economies such as the United States and Japan, a weakening rupee, the risk of higher domestic interest rates, and mounting concerns over fiscal slippage have all combined to temper foreign appetite for Indian debt.

"Outflows could continue intermittently as the impact of higher oil prices on India's macroeconomic outlook will be felt," said Dhiraj Nim, economist and FX strategist, ANZ Bank. "Debt inflows are likely to remain patchy amid growing risks of higher interest rates, rupee depreciation expectations and concerns over the fiscal deficit, all of which could keep foreign portfolio investors on the sidelines."

The FAR pertains to a specialised window, introduced by the central bank six years ago, that allows overseas funds to own specified Indian sovereign debt without caps.

ETMarkets.com

Near-term outlook for Indian debt remains challenging, with economists not expecting any meaningful inflows into Indian bonds. Over the longer term, substantial inflows are likely only if a significant catalyst emerges, such as the inclusion of Indian sovereign debt in a major global benchmark index like the Bloomberg Aggregate Bond Index.

The Indian rupee fell to a fresh record low of 95.33 against the dollar on Thursday, as a sharp rise in crude oil prices triggered a broader risk-off move across global asset classes. Higher oil prices have also intensified concerns over India's fiscal position, given the country's heavy dependence on energy imports.

The 10-year Japanese government bond yield reached a 29-year high of 2.52% on Thursday due to an increase in oil prices, according to Reuters. The 10-year US bond yield was up at 4.41%.

"The yield differential between India and US or Japan is also causing many FPIs to move out of emerging markets like India and invest in those bonds, especially at these rates," said a senior fixed income trader at a foreign bank.

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