In a first, foreign portfolio investors (FPIs) bought Rs 968 crore worth of state development loans (SDL) on Monday even as fresh investment limits opened up for government bonds through an auction.
In total, FPIs bought the right to invest close to R6,000 crore of Indian bonds in a single day. Market participants believe that notwithstanding the illiquidity of SDLs, the appetite from foreign investors would remain strong due to the attractive returns that state bonds give.
At its bimonthly policy last month, the RBI laid out a road map and said foreign investors would be allowed to buy government bonds of up to 5% of the outstanding stock by March 2018. The central bank for the first time allowed FPIs to buy SDLs and said the limits would be enhanced in tranches along with those of the government bonds.
In the first tranche opened up on Monday, FPIs could invest Rs 3,500 crore in SDLs and additional Rs 5,500 crore in government bonds. While state bonds would attract strong interest from FPIs, central government securities would still be the most preferred, bond traders said.
“The limits will get exhausted in a matter of days. We have seen this happen after yesterday’s auction of limits. SDLs may take a longer time. In terms of the credit ladder, central government bonds are unmatched and most preferred,” said Manish Wadhawan, MD & head of rates at HSBC. This was evident as the auction of investment limits worth Rs 5,600 crore in government bonds on Monday attracted bids worth a staggering Rs 17,266 crore. But state bonds too seem to have attracted strong investor interest.
According to dealers, FPIs bought bonds of Maharashtra, Tamil Nadu and West Bengal on Monday. But given that Indian bonds offer one of the highest returns among emerging market economies, foreign investors are picking up state bonds unperturbed by the illiquidity of these bonds.
“State bonds would appeal to foreign investors as they offer a higher yield than government securities. There is also a differentiation between states mainly due to perception although there should not be any difference between two state bonds or between an SDL and a government bond,” said Ashutosh Khajuria, head of treasury at Federal Bank.
Wadhawan, however, believes that the spread between the yield of a state bond and a central government security is largely due to demand and supply factors rather than perception. Currently, the yield on 10-year SDLs is around 40 bps more than the corresponding government bond yield. The 10-year benchmark government bond yield ended at 7.56% on Tuesday while the cutoff yield at an auction of state bonds by the RBI was around 7.95%.