The yields on Indian bonds are more attractive than the yields on the US bonds around 2.5%, even after factoring in a possible depreciation of the rupee
Foreign institutional investors (FIIs) have poured a record amount of money into the Indian debt market with year-to-date inflows of $13.7 billion, higher than inflows of around $12.04 billion into the equity market. The chart shows how unusual this is.
“There is a lot of demand for Indian bonds from foreign investors because yields are quite attractive for carry trade and the rupee has also been stable," said A. Prasanna, chief economist of ICICI Securities Primary Dealership Ltd. Indian bond yields have remained elevated at around 8.8% for the 10-year government 2023 bond, and prices have declined since the beginning of the year. The yields on Indian government paper are more attractive than the yields on the 10-year US treasury bonds at around 2.5%, even after factoring in a possible depreciation of the rupee.
Foreign investors have also taken comfort from the sharp narrowing of the current account deficit (CAD). Recall that last year, around the same period, there was a sharp sell-off in the bond market after the US Federal Reserve first spoke about reducing its monetary stimulus, which stoked concerns about how India would finance its large trade gap.
Although the US Federal Reserve is scaling back its bond-buying programme, volatility in the currency has eased and the rupee has appreciated by around 12.3%.
Bond dealers say that flows into government debt have eased after the RBI policy statement last week due to upside risks for inflation, but there was demand seen for corporate bonds as economic growth seems to be reviving.
The big question, of course, is: will rising interest rates in the US affect the flows into the Indian debt market? Recall that funds flowed out mainly from the Indian bond markets last year when the talk of tapering bond purchases first started. And in spite of having a much more manageable current account deficit, any hike in US interest rates could see outflows from the bond markets once again. “Once Janet Yellen starts talking about increasing their interest rates, it can create volatility across markets if not priced in correctly", said R. Arun, executive director-fixed income, Nomura Global Markets Research.
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