FPI inflows into bonds may lead to softer yields

Foreign fund flows into Indian bonds are likely to gather pace in the coming months leading to softer yields, at least in the first half of the current fiscal, after the Reserve Bank of India (RBI) on Friday increased the foreign portfolio investors’ (FPIs) investment limits for central government securities and corporate bonds.

In total, FPI investment limits in central government securities—for general and long term investors—have been increased by Rs 59,200 crore or over $9 billion to a total of Rs 3.15 lakh crore till the end of FY19.

The increase in limits comes at a time when the government has decided to reduce its market borrowing in the first half of the fiscal, while simultaneously reducing the duration of the papers it issues. Moreover, the RBI has also allowed banks to spread their mark-to-market (MTM) provisioning over four quarters.

As a result, market participants believe the benchmark yield is unlikely to surge over the 7.30% level in the short-run.

Ananth Narayan, professor-finance at SPJIMR, argues that FPIs have stuck to Indian bonds even in times when domestic investors were exiting their positions and the full utilisation of general category limits only points to continued foreign interest. “Given all the recent positives — a much milder H1 FY19 borrowing plan, bond MTM loss forbearance, the MPC statement underlining sharply lower CPI estimates and questions around supply/ demand resolved for now — the rally in bond prices may continue over the short run,” Narayan said.

In calendar year 2018, FPIs have infused over $638.90 million into Indian bonds on a net basis. In the last three sessions itself, foreign investors have infused over $500 million on a net basis.

Nomura points out in a report that the increase in limits should help FPIs to absorb approximately 12% of net supply for the year FY19 assuming the utilisation of these limits remain at current levels. “Overall, we continue to expect supply/demand issues to be resolved, and as such, we remain comfortable with our long bond positions with a bias to increase them on an uptick in yields,” Nomura said.

The corporate bond segment is the biggest gainer since the central bank has discontinued the existing sub-categories in the segment. The general category limit was almost fully utilised by foreign investors. However, the long-term FPI investor category, for which a limit of $2.92 billion was set aside before the limit review, saw only 1.07% utilisation according to latest depository data. Since this will now be available under one category, significant FPI inflows are expected in the corporate bond segment.

Vijay Sharma, executive vice-president for fixed income at PNB Gilts, pointed out that FPI limit review has been slightly disappointing for the G-sec market while it is seen as extremely positive for the corporate bond segment.

“Corporate bonds are getting decent bids due to the consolidation in the limits, as this is expected to attract more FPI fund flows. There has been decent buying activity in this segment in contrast to the profit booking seen in the G-sec market. The general feeling in the market is that 7.30% levels will act as support where buying activity might resume,” Sharma said. On Monday, the benchmark yield closed five basis points higher at 7.23%.