News Analysis

Indian bonds are falling out of favour with foreign investors

Radhika Merwin | Updated on February 14, 2019 Published on February 14, 2019

FPIs have utilised only half of their investment limits in government bonds

Foreign investors who have been pulling out of Indian debt markets, appear not too keen to come back in a hurry. Going by data put out in Clearing Corporation of India (CCIL) and National Securities Depository Limited (NSDL), from exhausting 82 per cent of their investment limits, FPIs have since September last year utilised just about half of their limits for government bonds. In corporate bonds, they are utilising about 70 per cent of their limits, from about 98 per cent last year.

Currently, the investment cap for FPIs in government bonds is ₹ 360,800 crore across categories and for corporate debt securities is ₹ 289,100 crore.

Limit raised

The RBI, in April last year revised FPI limits for both government and corporate bonds. For government securities, across central government securities and State Development Loans (SDLs) for all categories of investors and long term FPIs, investment limit was raised from ₹ 301,500 crore to ₹ 327,900 crore in the first half (Apr-Sept 2018) of FY19 and then to ₹ 3,60,800 crore in the second half (Oct 2018 to March 2019).

For corporate bonds, all existing sub-categories were discontinued and a single limit for FPI investment was fixed. From ₹ 244,323 crore the limit was raised to ₹ 266,700 crore for the first half of FY19 and ₹ 289,100 crore for the second half.

Also read: The skewed structure of India’s bond market

What’s irking investors?

Foreign investors’ interest in both government and corporate bonds has been dwindling over the past year. Sharp depreciation in the rupee, tightening global liquidity, RBI’s rate hikes and inflation risks — until September-October last year, had spooked foreign investors.



Rupee depreciated by a steep 14 per cent until October, and subsequently stabilised. But it still ended 2018 with a 6 per cent fall. For foreign investors, aside from returns, the bigger worry is on the movement in local currency, which if weak can erode overall returns. RBI also hiked rates twice last year, with the yield on 10-year government bonds peaking at 8.1 per cent levels in September.

From 82 per cent in the beginning of 2018, FPIs’ utilisation of limits went down sharply to 58 per cent by September 2018.

Domestically, PSU Banks sitting on large investments in government bonds also were huge net sellers in government bonds for the whole of 2018—net selling ₹ 76,541 crore.

What’s in store?

While high interest rates have always attracted foreign investors to Indian bonds, uncertainty over rupee, heightened political risk due to upcoming elections, and more importantly the Centre’s fiscal profligacy are key overhangs for FPIs. While rupee may remain within a range unless crude oil plays havoc, the sharp jump in gross borrowings in 2019-20 to a whopping ₹ 7.1 lakh crore, announced in the interim Budget, will keep investor interest subdued.

The ten-year Indian government bonds today trade at a yield of about 7.2-7.3 per cent; in the US similar gilts offer 2.7 per cent.

Taking inflation into account, the real returns on Indian bonds are attractive at around 5.3 per cent. But fiscal and election worries are big dampeners. Also, with the RBI embarking on the rate easing path, the attractiveness on returns could wane.

On a nominal basis, Indonesia offers high rates on its 10-year bonds, at 7.8 per cent. With inflation around 2.8 per cent, the real returns work out to about 5.1 per cent, more or less on par with India’s real rates. Indonesia’s improving macros and a relatively more aggressive monetary policy will continue to draw foreign investors.

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