Mumbai, Dec 15 - Foreign investors have exhibited increased caution towards Indian government bonds, leading to the highest weekly net selling of global index-linked debt in six months. Despite this recent selling pressure, many analysts remain optimistic about the long-term prospects for Indian debt.
The recent uptick in selling is attributed to a fading optimism surrounding near-term interest rate cuts, coupled with a rise in U.S. Treasury yields. Last week, bond yields experienced a notable increase, influenced by substantial activity in overnight index swaps and position adjustments by foreign investors, which triggered a sell-off in the Indian bond market. The benchmark bond yield rose by 10 basis points, marking its most significant increase since mid-August.
However, it's important to note that this selling occurred amidst expectations of India's inclusion in global bond indices. While the inclusion is expected to bring in substantial foreign investment in the long run, short-term factors continue to influence investor sentiment. India's government bonds are set to be included in the JPMorgan Emerging Market local currency debt index from June 28, and both Bloomberg Index Services and FTSE Russel will add Indian debt to their emerging market bond indexes in January and September 2025, respectively.
Market analysts suggest that the recent selling might be a temporary phenomenon. Some experts believe that the strong domestic institutional investor (DII) participation could offset the impact of FPI outflows. Moreover, India's robust growth and earnings outlook make sustained selling seem unsustainable.
The Reserve Bank of India (RBI) is actively managing liquidity in the market. The RBI will purchase bonds worth 500 billion rupees ($5.52 billion) on Thursday and has included more liquid papers, including the 7.18% 2033 and former benchmark 6.33% 2035 bonds. This follows a similar purchase last week, which provided some relief to the market.
Despite the recent volatility, the long-term outlook for foreign investment in Indian debt remains positive. Factors such as narrowing yield spreads and global uncertainties may lead to temporary outflows, but the inclusion in global bond indices is expected to drive significant inflows. Furthermore, the Indian bond market remains one of the largest and most liquid in emerging markets.
In the currency market, the Indian rupee is expected to remain under pressure due to weak flows and the absence of a U.S. trade deal. The rupee hit a record low of 90.55 before closing at 90.4150 on Friday, down 0.5% on the week and set for its worst yearly fall since 2022.
Overall, while the recent foreign selling in Indian index-linked debt indicates short-term caution, the underlying sentiment towards Indian debt remains bullish, driven by expectations of index inclusion and strong domestic fundamentals.
