Mumbai: Domestic bond yields could fall on expectations that foreign portfolio investors (FPIs) will resume buying Indian debt, bond dealers said, after easier investment rules announced on Friday. This may also lift some pressure on the rupee, which has been falling against the dollar.

The Reserve Bank of India (RBI) late on Friday withdrew a rule that mandated FPIs to invest in government bonds with at least three years of residual maturity. Also, FPIs are free to buy corporate bonds with at last one year residual maturity, against three years earlier.

According to bond dealers, there is little appetite for Indian bonds among foreign and domestic investors now.

This is because of higher yields owing to uncertainty over interest rates, falling rupee and volatile external factors such as rising crude oil prices and US bond yields. 

FPIs have been net sellers in the Indian debt market for the past two months and the trend is expected to continue in April.

The new rules are likely to improve market sentiment as they are favourable for foreign investors. This, in turn, should generate demand for bonds from other domestic investors, dealers said.

“It will help improve the current market environment. And FPI flows in debt market may return because foreign investors have always preferred the 1-3 year maturity investment bucket. Corporate bond supply may also increase in this bucket on expectation of higher FPI demand, which may lead to a fall in yields by at least 25-30 basis points on immediate basis," said Jayen Shah, head of debt capital markets at IDFC Bank. 

Rates on AAA-rated corporate bonds of public sector entities, seen as a proxy for sovereign, maturing in up to three years have risen to around 8%.

Yield on benchmark 10-year government bond has risen to 7.761%. Bond yields and prices move in opposite directions. 

FPIs, under the open category have exhausted nearly 95% of their total investment in government bonds and over 79% in corporate bonds.

FPIs typically prefer short-term bonds for the so-called carry trade. Here, the investments in higher yielding in emerging market assets are funded through borrowings at lower rate, such as dollar borrowings.

Ajay Manglunia, executive vice-president and head-fixed income at Edelweiss Financial Services, said that post these rules, FPIs should be net buyers in debt market because even after hedging, interest rate differential is still attractive for foreign investors.

“Expectation of returning flow may also help ease some pressure on the rupee," he said. 

The rupee has been under pressure because of fears that rising crude oil prices may weaken India’s macroeconomic fundamentals. So far in 2018, the rupee has fallen 4.32% against the dollar.

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