Debt inflows outpace equity rally on high interest rates

Written by Sandeep Singh | New Delhi | Updated: Sep 17 2014, 13:24pm hrs
DebtThe FII inflow into Indian debt, most of which has gone into government securities, is the highest ever. Reuters
The FII rally this year is not limited to the stock markets only. In fact, the Indian debt market has witnessed a better inflow with foreign institutional investors pumping in a record Rs 1,12,469 crore ($18.6 billion) in the debt market till date in 2014.

Improved fundamentals of the Indian economy, a decisive mandate to the BJP-led NDA and high interest rates caught global investors attention as they have invested an aggregate of Rs 1,97,716 crore (all-time-high) in debt and equities with the debt inflow far higher than those witnessed in equities.

The FII inflow into Indian debt, most of which has gone into government securities, is the highest ever. The previous best was in 2010 when it stood at Rs 46,408 crore.

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Market players, too, were taken by surprise. Nobody expected inflows of around $18 billion in Indian debt. The RBIs move to go for a targeted inflation number and the mandate for a stable government established a lot of credibility among investors leading to the strong inflows, said Nandkumar Surti, MD & CEO of JP Morgan AMC India.

The inflow is also significantly higher than the FII inflow into equities, which till date have reached Rs 85,247 crore ($14.17 billion). Between May and August, after the new government was formed, FIIs invested a total of Rs 76,124 crore in Indian debt that reflects their comfort derived from the election result.

As most developed economies have been offering significantly lower interest rates, experts say that investors moved into Indian debt market to take advantage of the arbitrage opportunity available to them while investing in the country at a time when its fundamentals have significantly improved.

While the borrowing cost for FIIs in developed markets stood anywhere between 2 per cent and 2.5 per cent, they could earn around 8-8.5 per cent in India. If they do not hedge, then the earning for them could go up to 5-6 per cent, said the chief investment officer with a leading mutual fund in India.

Investors have also drawn comfort from RBI Governor Raghuram Rajans action as he has maintained focus on bringing down the inflation and also keeping the rupee stable. Also, a possibility of an upward revision of Indias sovereign rating has boosted investors confidence.

After Rajan came in, there has been a considerable comfort that induced inflows. There is also a thought that India deserves a better rating which is reflected from the fact that large Indian companies that trade in markets enjoy better rating than other BBB(-) rated countries, said Abheek Barua of ICRIER.

He added that money has been flowing in both for the short- and long-term debt. While sizeable FII money has already come into debt, a lot will depend upon the US Federal Reserves decision on interest rates.

If the US decides that it will hike the interest rates then the markets will start pricing in and the arbitrage may squeeze in and that may result into outflow of funds. However there is a significant arbitrage present and the perception towards rupee has also changed, said Barua.