After turning net sellers of government bonds under the fully accessible route (FAR) for the first time since India’s inclusion in the JP Morgan Global Market Index — Emerging Suite in November, foreign portfolio investors (FPIs) have again turned net buyers in December.
FPIs increased their positions held under the fully accessible route to Rs 2.51 lakh crore against Rs 2.43 lakh crore a month ago.
The appointment of the new governor of the Reserve Bank of India has boosted the expectations of a rate cut in February.
This prompted foreign investors to take a positive view on the government bond market despite the rupee being under pressure. The new RBI governor, Sanjay Malhotra, is perceived to be dovish in his approach, therefore, the market is confident about India going for a rate cut in February, said traders.
If the central bank does not go for a rate cut as expected, it may announce additional measures to infuse liquidity in the market, such as open market operations or buybacks.
These will in turn help yields on the government securities to ease. Moreover, end of supply of government bonds in February is also boosting the demand for the same.
Hence, the interest rate differential between safe-haven and emerging markets would narrow, making latter more appealing to the foreign investors.
However, the sharp depreciation in the rupee, driven by dollar strengthening, and surge in the US Treasury yields, prompted foreign investors to not take aggressive bets on the domestic bond market.
Another factor that has slowed down the pace of foreign flows in the government bond market is expectations of the rupee getting depreciated further. Since the domestic currency being overvalued by 8% vis-a-vis its Asian peers, apprehensions of it falling further has risen.
“Foreign investors are worried and apprehensive about the rupee depreciating further as dollar is expected to remain elevated. Therefore, they are not taking large or aggressive bets in the government bond market,” said a trader with a foreign bank.
Since September 17, when the US Federal Reserve cut the interest rate, the dollar has strengthened by 7%.
Consequently, the dollar index has risen from 105.44, after Donal Trump won the US presidential elections, to 108.
The index has been hovering around 108 levels, since the last meeting of the US Fed, where Jerome Powell, US Fed chair, hinted at a cut of 50 basis points in 2025, against the earlier expectations of 100 basis points.
Another global factor which prompted foreign investors to move to safe-haven assets was the surge in the US Treasury yields, said traders.
In December alone, the 10-year US Treasury yields rose 35 basis points to 4.52%, whereas, the yield on the 10-year benchmark remained range bound, with moving between, 6.76-6.79%.
Looking ahead, foreign flows in the domestic bond market are expected to remain tepid as dollar and the US yields are anticipated to remain elevated. A shift to the hawkish tone of the US Fed’s commentary has acted as the major dampener for the emerging markets such as India. Along with hawkish US Fed stance, the uncertainty around the new policies to be taken by the new administration of Donald Trump is likely to keep foreign flows subdued.
“Trajectory of the rupee, new US policies, and of course domestic rate cut, these are the three crucial factors at which the market is looking at currently. All these will decide how the new year is going to be for the bond market,” said a trader at a private bank.