Mumbai: The rupee depreciation and a narrow gap between returns on Indian government bonds and those on US bonds have kept foreign investors wary of Indian debt markets.
India's benchmark 10-year government bond yields 7.004%, compared with 4.435% on the US 10-year Treasury, leaving a spread of about 256 basis points, according to the latest available data.
The yield spread, around the start of the war, was at around 272 bps and dropped to 235 bps in March, before recovering. While spreads have improved compared to where they were in 2025, experts said they have historically been above 300 bps.
This, along with the rupee depreciating roughly 3.4% against the dollar since the beginning of the West Asia war, made Indian bonds unattractive.
At a conference in Hong Kong last week, several foreign portfolio investors said the rupee’s persistent decline was making them reluctant to increase exposure to Indian assets, Mint reported on 25 May.
The caution is reflected in investment flows. So far this financial year, FPIs have been net sellers of $836 million in the general debt route, $490 million in the voluntary retention route (VRR), but have been net buyers of $448 million in the passive fully accessible route (FAR), showed data from NSDL.
Inflows through the last route are a result of Indian debt being included in Bloomberg and JP Morgan indices.
In the general category or the default route, FPIs are bound by investment ceilings; in VRR, they plan long-term investments that offer some regulatory relief. FAR allows non-residents to invest in specified Indian government securities without investment ceilings.
“From a fully hedged foreign investor perspective, India is currently meaningfully below the comfort zone required for aggressive debt allocations,” said Venkatakrishnan Srinivasan, managing director and chief executive at Rockfort Fincap LLP, a debt syndication firm. “The nominal spread appears attractive on paper, but the effective carry is not compelling once currency protection is factored in.”
However, India is moving closer to a stabilization phase rather than the beginning of a prolonged capitulation cycle unless the geopolitical situation escalates materially further, Srinivasan said.
The broader macro picture, he said, has not fundamentally changed. “India still enjoys relatively strong macro credibility among emerging markets because policymakers have largely maintained stability through multiple global shocks over the last decade.”
The selloff in Indian bonds is significantly lower than the one seen in equities. Foreign investors have sold $9.9 billion in Indian equities on a net basis so far in FY27. The war in West Asia has complicated things as rising oil prices risk inflating India’s import bill. Exit of foreign capital makes it worse for the currency, even as the central bank tries to cushion the blow.
RBI governor Sanjay Malhotra told Mint in a recent interview that with the recent depreciation, it would be reasonable to think that the rupee is not overvalued and if anything, it has become undervalued.
Structural concerns
Some experts said, for a long time, India benefited from being treated as a relatively self-sustaining growth story, where the external balance adjusted quietly in the background. That assumption is now being reconsidered.
Siddharth Chaudhary, head of fixed income at Bajaj Finserv Asset Management Ltd said the recent energy shock has revealed that India remains structurally dependent on external inputs at exactly the moment global capital has become more selective.
“The real question investors are asking is more uncomfortable: not whether India can grow, but whether it can fund that growth smoothly when both the size and stability of external financing are in doubt,” said Chaudhary.
He said when developed market yields were near zero, investors were willing to accept complexity in exchange for incremental return.
“That is no longer the case. Today, alternatives exist that require less interpretation and less hedging risk. So, this is not about whether yields are high or low. It is about whether the return is clean enough to justify the exposure and right now, for many investors, India looks like a market where too many of the variables sit outside the bond itself,” said Chaudhary.
Others see it as temporary. Amid the uncertainty and geopolitical tensions, all investors, including FPI, have been cautious and are avoiding currency risks.
“Hedging costs are improving and likely to reflect in better flows; markets need clarity and these unpredictable situations are always keeping investors jittery,” said Ajay Manglunia, executive director at non-bank financier Capri Global Capital Ltd. “India is very stable with continuity of policy, strong fundamentals, growth and improvement in all macro numbers besides things related to imports, oil and flows.”