A sharp rise in bond yields over the past one week, along with results of state assembly elections over the weekend, led to value-buying from FIIs, dealers said.
Assembly election results in four states strengthened hopes of a strong showing by the BJP in the 2014 general elections. Many market participants believe that a BJP-led government would be more pro-reform and speed up legislative steps needed to boost economic growth.
Further, a sharp rise in bond yields, especially of the 10-year benchmark bond, had made them more attractive to investors. The 10-year 8.83%, 2023 bond yield had risen for five consecutive days by a total of 14 bps. On Tuesday, the bond yield eased 5 bps to end at 8.84%.
Yields are likely to inch up again in the coming days on worries that retail inflation may not cool off, thereby strengthening the case for further rate hikes by the Reserve Bank of India.
Bond dealers said some investors may have found value in buying at the current levels and the recent buying may not reflect a longer-term trend. Sentiment is still jittery and most FIIs are cautious owing to the imminent tapering of quantitative easing by the US Federal Reserve, dealers said.
Even though on some days there could be buying, FII outflows could continue because of the taper talk, said a trader at a foreign bank. FII outflows have been continuing from the domestic bond market ever since foreign investors started pulling out of bonds in May when the US Fed first indicated that it may soon start paring its bond-purchasing programme.
In the aftermath of this selling, the total holding of FIIs in debt has come down to a mere 31% or $25 billion from a high of around 60% or $45 billion in April. Total investment by FIIs in bonds is capped at $81 billion.
The outflow caused bond yields to surge more than 100 bps and the rupee to hit an all-time low of 68.85/$ in August. So far in 2013-14, FIIs have pulled out $11 billion from the domestic bond market.