Mumbai: Indian debt offers a good return to foreign investors and the interest rate differential will attract more foreign fund flows into corporate debt, a senior bank treasury official told Reuters on Friday.
Foreign institutional investors (FIIs) have so far invested Rs870 crore in Indian debt so far this year compared with Rs105 crore in 2009.
“The yield pick-up in India is very attractive for foreign institutional investors and with the FII holdings of debt having nearly doubled in the last 12 months, the gap between FII holdings in debt and equity has narrowed considerably,” said Ramit Bhasin, head of markets, at Royal Bank of Scotland (RBS).
“The gross 10-year yield differential of 5.5% is very attractive even after accounting for cost of funds and forward dollar cover for the FIIs,” he said, referring to the differnece between US and Indian yields.
Rising interest rates in India to counter inflation, at a time when authorities in Europe and US are still following an easy monetary policy has led to an attractive rate differential.
The spread of corporate bond yields over corresponding government yields in the five-year segment stands at around 65 basis points (bps), according to Thomson Reuters data.
Bhasin also expects a strong demand for debt domestically at 8.25-8.50% levels for the 10-year bond from insurance companies and pension funds.
“In the next few months with the rate hikes behind us, we expect more FII flows into debt and especially corporate bonds,” Bhasin said.
“I think going forward more limits under corporate limits will be available.”
The current limit on FII investment in Indian corporate bonds currently stands at $15 billion.
Three more rate hikes in 2010
The Reserve Bank of India (RBI) may lift policy rates in September, November and then again in late December, narrowing the corridor between the repo rate and the reverse repo to 100 basis points from the current 125 basis points.
“The 1-year OIS rate at 6.25% implies three rate hikes of 25 basis points each,” said Bhasin.
According to Bhasin, 1-year OIS yield at 6-6.25% is fair value and he recommends receiving it at 6.50% levels in the near-term.
An expected cash crunch in the system in the second-half of September as a result of advance tax outflows mid-month will be temporary and the central bank will maintain adequate liquidity.
“While RBI may want liquidity to be tight for the next six months to fight inflation, they will ensure that there are no abnormal spikes and the market is orderly,” he said.
He expects the RBI to conduct the second liquidity adjustment facility if there is too much cash shortage.
He expects inflation to trend down on a month-on-month basis to around 7% by March 2011, while the central bank projects it at 6% in the same period.
“By December, after the rate hikes, I don’t think RBI will be behind the curve especially in the light of what’s happening in Europe and US with their economies slowing,” he added.
Inflation-linked bonds, which are under consideration at the central bank as well as the finance ministry, may be of interest to the government as well as long-term investors, Bhasin said.
“But it should not be an adhoc issuance. The market should be told of size, tenor and what percentage of yearly borrowings will be in inflation-linked bonds in advance,” he said
The most suitable tenors for inflation-linked bonds would be 5-year, 10-year and 20 years, he added.