FPIs find stability in Indian debt amid equity challenges; what’s behind the inflows into bonds?

Indian bonds have started the year 2024 on a robust note, outperforming equities in January and achieving their best performance since 2019, propelled by substantial FPI inflows into the debt market. Consequently, the Indian 10-year government bond yield dropped to 7.02% during Friday's trade (February 2), marking the lowest level since mid-July.

In January, FPIs injected a notable ₹19,800 crore into Indian bonds, marking the highest monthly inflow in six years, surpassing the inflows of ₹18,302 crore observed in December 2023. This positive momentum extended the ten-month streak of inflows in the debt market since April 2023, with the last recorded net outflow occurring in March 2023, amounting to ₹2,505 crore.

Also Read: After a strong 2023, FPIs turn net sellers in January 2024; will this trend continue?

Conversely, FPIs exhibited a divergent trend in the equity market, withdrawing ₹25,744 crore from Indian stocks in January. Before January, FPIs were net sellers in October 2023, divesting Indian equities worth ₹24,548 crore. However, in the subsequent months of November and December 2023, they shifted their stance, acquiring equities worth ₹9,001 crore and ₹66,135 crore, respectively.

Looking at the overall scenario in CY23, FPIs displayed substantial engagement in the Indian equity market, investing a total of ₹1.71 lakh crore. In the debt space, FPIs injected a total of 68,663 crore throughout 2023.

Notably, the calendar year 2023 marked a significant shift, with FPIs becoming net buyers of Indian debt for the first time in four years. The last instance of net buying of Indian debt by FPIs occurred in 2019, amounting to ₹24,058 crore.

Why are FPIs pumping money into the Indian debt market?

Dr V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services, outlined three primary reasons behind the increased infusion of funds by Foreign Portfolio Investors (FPIs) into the Indian debt market in January while exiting Indian equities at the same time.

Firstly, he pointed out that US bond yields increased to around 4.16% in January from approximately 3.88% in December 2023, leading to capital outflows from equity towards higher-yielding US bonds. Secondly, he highlighted that Indian equity has become one of the most expensive in the world, with the Nifty trading at a PE of around 21 based on FY24 estimated earnings, triggering selling in the Indian equity market.

Thirdly, Dr. Vijayakumar mentioned that some FPIs are engaging in front-running in the Indian bond market, anticipating increased flows after India's inclusion in the JP Morgan Emerging Market Bond Fund.

Also Read: RBI Monetary Policy Committee meeting: Check the date, time, and where to watch

Looking ahead, he emphasised that FPI inflows into the equity market will hinge on trends in US bond yields and global as well as Indian equity market conditions. With recent corrections in US bond yields, significant FPI selling in February is unlikely. There may even be a shift towards buying, while inflows into the debt market are expected to persist, according to Dr Vijayakumar.

Inflows are likely to be strong

In September last year, JP Morgan announced that it will add Indian government bonds to its benchmark emerging market index. India’s Fully Accessible Route (FAR) securities will be included in the JP Morgan GBI-EM Global Diversified Index (and other related indices) from June 28, 2024, with a weight of 10%, staggered over 10 months.

According to analysts, this inclusion will raise FPI ownership in Indian GSecs to around 3.5%–4.0% by FY2025, up from 1.6–1.7% currently. In value terms, this move is expected to bring approximately US$30 billion in inflows in the same period.

India has been on Index Watch Positive since 2021 for inclusion into the GBI-EM following the Indian government’s introduction of the FAR program in 2020 and substantive market reforms for aiding foreign portfolio investments. FAR bonds are securities that have no restrictions for foreign investors and are eligible for global index inclusion.

Also Read: Indian government bonds likely to be part of Bloomberg emerging market index from September 2024

In addition to JP Morgan, Bloomberg Index Services last month said it is soliciting feedback on a proposal to include India’s Fully Accessible Route, or FAR bonds, in its emerging market local currency index.

"The inclusion of Indian government bonds in the JP Morgan Index (in June 2024) will have a significant impact on the inflows. This inclusion has made Indian bonds more appealing to foreign portfolio investors (FPIs). The prospect of India's inclusion in the index has sparked increased interest in and investment in Indian debt securities," said Abhijit Roy, CEO of GoldenPi.

"The inflow of foreign capital into India's debt markets is expected to strengthen the rupee. When foreign investors buy Indian bonds, they must convert their currency into Indian rupees, increasing demand for the rupee. A stronger rupee has several advantages, including lower import costs, especially for commodities such as crude oil, and lower inflationary pressures," Abhijit Roy further added. 

Lower fiscal deficit target

Further boosting the positive sentiment in the Indian debt market, the Indian government, in the interim budget, set a fiscal deficit target for FY24 at 5.8%. Surprisingly, the fiscal deficit target for FY25 has been set even lower at 5.1%, surpassing market expectations that ranged between 5.4% and 5.5%. This move has retained optimism in the market, with a long-term target of reaching 4.5% by FY26.

"The government's target of a lower fiscal deficit will translate to lower borrowings by the government. This means that the yields of government securities will ease out. Also, with lower government borrowings, there will be more headroom for private sector entities to raise capital. This means we will see more private entities going via the bond issuance route to raise capital from the market," said Abhijit Roy, CEO, of GoldenPi.

"Also, lower borrowings will signal to the external world that the Indian economy is in a stabler state, which can boost confidence in FPIs to pump in more funds into Indian securities. All in all, all signals combine to make India an investment-worthy destination for foreign funds and for growth in the Indian economy by allowing the private sector to raise more capital for their business expansions," he further added.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before making any investment decisions.