NEW DELHI – It is no secret that the global economic upheaval caused by Russia’s invasion of Ukraine and aggressive monetary tightening plans by the US Federal Reserve has prompted overseas investors to exit Indian equities in droves.
While the foreign outflows from Indian equity markets have dominated the recent headlines, the latest data on overseas investment activity in debt doesn’t do anything to improve the outlook on Indian financial assets.
NSDL data showed that so far in the current calendar year, foreign portfolio investors have net sold Rs 13,177 crore worth of Indian debt. This outstrips the Rs 10,359 crore worth of net sales in the whole of 2021.
While the NSDL data shows the trend for overall debt assets, the figures provided by the Clearing Corporation of India show the FPI sales figures for government securities.
The selling pressure in debt may be much lower than that shown by FPIs in the stock markets, but the figures are definitely not encouraging.
So far in the current calendar year, FPIs’ net investment in government securities has reduced by Rs 9,323.85 crore. For comparison, FPIs had net sold Rs 13,448.48 crore worth of Indian sovereign bonds in the previous calendar year as a whole.
Investment under the Fully Accessible Route, however, has increased by Rs 3875.66 crore so far in 2022, the CCIL data showed. The FAR, which was introduced in the Union Budget for FY21, permits full investment in specified government securities for non-resident investors without any restrictions.
The introduction of the FAR is seen as a step taken to facilitate the long-awaited listing of Indian government bonds on global indexes.
THE FED BLITZ
Key factors cited by market participants ET Markets spoke to were worsening of India’s macroeconomic fundamentals and the US Fed’s plans for higher interest rates.
Higher interest rates in the world’s largest economy dim the appeal of riskier fixed-income assets in emerging markets such as India.
Over the last year, the yield on the 10-year US Treasury bond, a global benchmark for debt, has surged 129 basis points, reflecting the monetary tightening plans of the country’s central bank.
With the Fed, which has raised interest rates by 75 basis points already in 2022, widely expected to hike rates by 50 bps each in June and July, US bond yields are likely to head even higher.
This reduces the appeal of Indian debt securities, especially when one takes into account the erosion of Indian fixed-income asset returns due to surging inflation.
“The Fed is very much poised to hike by 50 basis points in the next two policies and there could possibly be the third hike after that. So, the RBI cannot take it easy, that is for sure,” ICICI Securities Primary Dealership’s Head of Trading Naveen Singh said.
“Things are not looking good for bonds. India’s inflation is running too high; the real interest rates are still negative. They (FIIs) might be getting a positive real rate elsewhere,” he said.
TIGHTER DOMESTIC POLICY, HUGE SUPPLY
Not only do Indian bonds suffer from the perspective of real returns, but also from the risk of capital losses as the RBI raises interest rates and tightens liquidity conditions. The RBI is seen hiking the repo rate by around 75-100 basis points in the current financial year to tackle surging inflation.
When the central bank hikes interest rates, the cost of funds rises and bond yields follow suit. When bond yields rise, prices fall, leading to marked-to-market losses on debt portfolios.
Amid such a volatile outlook, traders with a short-term view may maintain an arm’s length from Indian bonds. Yield on the domestic 10-year benchmark government bond has climbed a whopping 101 basis points so far in 2022, implying huge treasury losses for traders.
What makes the outlook worse is the large mismatch in the demand and supply of bonds. The Centre is scheduled to sell an enormous Rs 14.30 lakh crores worth of bonds on a gross basis in FY23.
And this time around, the bond market does not have the comfort of relying on the RBI as a large buyer of government paper, as the central bank is looking to bring down surplus liquidity. Bond purchases by the RBI add durable liquidity to the banking system.
With the government having recently announced a large increase in fertiliser subsidies along with sharp cuts in fuel excise duties, analysts fear a fiscal slippage in the current year. This brings with it the possibility of more government borrowing and, therefore, even more bond supply.
“The demand-supply gap in bonds remains a challenge this year. While the RBI has committed to a multi-year withdrawal of excess liquidity, the risk of higher government borrowing suggests increased market scrutiny over the potential of open market operations to absorb government bonds, which runs antithetical to the RBI’s liquidity tightening stance,” economists from Nomura wrote in a May 22 note.
Senior treasury officials did say, however, that if the Federal Reserve were to engineer a recession in the US economy in order to bring down inflation, foreign funds could find renewed appetite for Indian bonds.
“There will be buying support from FPIs once our 10-year bond yield goes to 7.75-8.00 per cent levels,” a treasury official at a large foreign bank said. The 10-year bond yield was last at 7.46 per cent.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)