Bonds yields are expected to reverse their rising trend after the Reserve Bank of India (RBI) relaxed the rules which allow foreign investors to buy shorter maturity bonds.

What are the new norms?

RBI has relaxed rules for foreign portfolio investors (FPIs) to invest in Indian bonds. It has withdrawn the clause that forced FPIs to buy government bonds and state development loans with at least three years of residual maturity. However, investment in bonds with maturity below a year must not exceed 20% of the total investment of that FPI. RBI has increased aggregate FPI investments in a single government bond to 30% of outstanding stock from 20% earlier. The central bank also removed the three-year residual maturity rule for corporate bond investments by allowing FPIs to buy securities with at least one year maturity.

Why did RBI relax these rules?

No reason is specified. However, the market speculates that such changes reflect RBI’s review of the bond market, which is struggling with lower demand and rising yields. Some bond dealers believe this move was necessary as rising yields, partly because of external factors, were impacting government borrowing and bank balance sheets. In the previous two weekly auctions of government bonds, RBI did not manage to sell part of the shorter maturity securities on offer, which were then devolved on primary dealers. This signals two things—weak demand and RBI’s unwillingness to auction bonds at higher yields, debt dealers said.

Why are bond yields rising?

Indian yields have been rising over the past few months, reflecting uncertainty over interest rate trajectory, a falling rupee and volatile external factors. This has led to lower demand, both among foreign as well as domestic investors. Yield on the benchmark 10-year government bond has risen to 7.76%, up by around 44 basis points since early 2018.

What do the new norms imply?

FPIs have always preferred shorter maturity bonds. The expectation that they will resume investments should generate demand for bonds from other domestic investors. Overall yields on government securities are seen falling by 10-15 basis points (bps). Corporate bonds, which are priced at a premium over government bonds, should also see at least 25 bps fall in yields. RBI’s relaxation is also seen to be positive for the rupee, which has been falling against the dollar. One basis point is one-hundredth of a percentage point.

Will a fall in yields be sustainable?

The relaxation may spur demand for bonds immediately but whether it will sustain is not clear. This is because fundamental factors behind the rise in yields have not changed. According to Nomura, the relief to the bond market is only tactical and rate hike expectations and oil price uncertainty still weigh on the market.