Photo: Mint
Photo: Mint

Fiscal slippage woes spark FII sell-off in debt markets

  • Foreign institutional investors sold nearly $1.08 bn of debt in past 13 trading sessions
  • Analysts say they aren’t worried as FIIs are selling short-term and buying long-term yields

MUMBAI : Foreign institutional investors (FIIs) have turned net sellers of Indian debt over the past two weeks following concerns about fiscal slippage, hardening inflation and slowing economic growth.

FIIs have sold nearly $1.08 billion of debt over the last thirteen trading sessions. They have been sellers on all days barring two. So far this year, FIIs have bought domestic debt worth $4.41 billion.

“FIIs’ sale of debt securities is not worrying as they are looking to take higher interest rate risk by selling short-term and buying long-term yields. We have seen increased buying in the longer end of the yield curve," said Ashutosh Khajuria, chief financial officer, Federal Bank, adding that the demand for short-term debt has fallen as the market is not convinced of a rate cut as inflation is inching up and fiscal deficit is expected to widen.

The Reserve Bank of India (RBI) has cut policy rates by 135 basis points so far in 2019 and the market expects the central bank to maintain an accommodative policy stance as long as it is necessary to revive growth, while ensuring inflation remains within target. With retail inflation breaching RBI’s medium target of 4% in October, economists expect it to do a balancing act.

Graphic: Naveen Kumar Saini/Mint
Graphic: Naveen Kumar Saini/Mint

The spread between the repo rate (5.15%) and the new 10-year government bond yield (6.5%) have also widened to 135 basis points, which is unusual in a rate cutting cycle. Bankers said the market is expecting higher government borrowing due to the possibility of fiscal slippage by the end of the calendar year. Brokerages and rating agencies are expecting the fiscal deficit to slip to 3.7%, higher than the 3.3% target for 2019-20.

“Higher spread in the sovereign paper is due to the fear of prospective excess supply due to fiscal slippage. Clarity on this and the resolve of authorities to compress the spread will be effective in passing on the benefit of benign interest rate to compress the sovereign spread vis-a-vis overnight rate, which will affect corporate credit spread and also the economy," said Gopal Tripathi, president and head, treasury, Jana Small Finance bank.

However, some market participants believe that the selling by FIIs was due to the year-end profit booking. “There are signs of rotation in FII holdings, trimming positions in the debt markets and shifting to Indian equities. Benchmark equity indices continue to scale new highs, encouraged by supportive measures from the government and in anticipation of a revival in earnings in the new year," said Radhika Rao, economist, DBS Bank.

“On the debt end, much of the positive newsbytes have been priced in, including an easing monetary policy bias, while investors eye the upcoming budget for signs of fiscal path, consolidation or slippage; we see risks of a small miss in the deficit target," added Rao.

On Wednesday, finance minister Nirmala Sitharaman indicated the possibility of a fiscal slippage in FY20, but maintained that the Centre is up for the challenge.

Analysts expect economic growth to fall below 5% for the September quarter on the back of weakening industrial production. The gross domestic product data is due on 29 November.