Demand for Indian bonds skyrockets in recent months
This trend can be attributed to several factors, including improved liquidity conditions in the financial system, a decrease in global bond yields, increased Foreign Portfolio Investor (FPI) inflows into the Indian debt market, anticipation of a Federal Reserve rate cut, LPG price cut, and the inclusion of Indian government securities into the Bloomberg Emerging Market (EM) Local Currency Government Index.
Consequently, the performance of the debt market has surpassed that of the equity market this year so far. It’s important to note that bond prices and yields have an inverse relationship: when bond prices rise, yields decrease, and vice versa.
Inflows continue: FPI inflows continued in March as they injected ₹3,316 crore in debt markets so far, following a ₹22,419 crore investment in February. The average monthly debt investments made by foreign portfolio investors have seen a remarkable increase since September 2023.
FPI demand for government bonds was attributed to Bloomberg’s inclusion of G-Secs in its emerging market local currency index, following the steps of JPMorgan’s inclusion of Indian bonds in its emerging market debt index.
As per a report by UBS Global Strategy, with JPM GBI-EM’s benchmarked AUM of $236 billion, India could potentially record about $25 billion of foreign portfolio flows, phased over the 10-month period starting in June 2024.
Furthermore, Bloomberg’s phased inclusion of Indian bonds in the Bloomberg Emerging Market Local Currency Index and related indices, starting from January 31, 2025, could attract additional flows associated with these indices.
In addition, the review for the potential inclusion of local bonds in the FTSE Russell’s EM bond gauge is due later in March.
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LPG price cut: This week, the domestic 10-year benchmark yield started off on a downward trend following the government’s announcement of a cut in LPG prices, which is expected to lead to a decrease in inflation. On Friday, the government announced a ₹100 reduction in the price of LPG cylinders.
Liquidity enters surplus territory due to government spending: System liquidity as of March 7 closed at a marginal deficit of ₹0.09 trillion. Liquidity in the banking system entered surplus territory for the first time since December 6 on the back of government spending.
As a result, the RBI conducted a series of variable-rate reverse repo (VRRR) auctions, mostly of overnight tenors. They absorbed a cumulative amount of ₹2.2 trillion. The RBI also conducted a 15-day Variable Rate Repo (VRR) worth ₹500 billion on Thursday to partially offset the maturity of an earlier VRR auction, said ICICI Global Markets in its latest report.
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However, excise duty outflows and VRR maturity took system liquidity to a marginal deficit on Thursday (March 7). Given the easing liquidity conditions, the daily average for the weighted average call rate (WACR) stood at 6.47% vs. 6.52% for the week prior.
ICICI Global Markets said that the liquidity conditions could ease this week, with the RBI expected to take delivery of the sell/buy swap worth ₹5 billion. This is expected to inject ₹400 billion into the banking system. However, advance tax outflows are expected to start by the end of the week, which is expected to tighten liquidity conditions, it added.
Robust economic growth: The robust performance of the Indian economy continued as the GDP expanded by 8.4% in the December quarter, surpassing expectations of 6.6% growth. This impressive growth lifted the second estimate of the current fiscal year’s growth to 7.6%, signaling a strong momentum in economic recovery.
This strong expansion has reduced credit risk in Indian government securities after the release of a prudent interim budget for the next fiscal year. The government plans to reduce the fiscal deficit for the 2024–2025 financial year to 5.1% from the revised 5.8% in FY24.
Drop in US bond yields: Another contributing factor to the surge in demand for Indian bonds was the decline in 10-year US bond yields, dropping to 4.08% from 4.3%. This reduction came amidst economic data weaknesses and recent statements from Federal Reserve Chair Jerome Powell, raising expectations of a potential rate cut in June.
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Traders are closely monitoring the release of US inflation data scheduled for today, which serves as the final major economic indicator before the Fed’s policy decision next week. According to the CME FedWatch tool, the probability of a rate cut in June currently stands at around 69%, up from 64% last week.
Meanwhile, India’s retail inflation data is also due later in the day and is forecast to print at a four-month low of 5.02% in February, according to a Reuters poll.
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.
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Published: 12 Mar 2024, 12:24 PM IST
