FPI Inflows into Indian Government Bonds Slow Down Amid Geopolitical Tensions and Narrowing Yield Differential

After record foreign portfolio investor (FPI) inflows into Indian government bonds in June, purchases via the fully accessible route (FAR) have slowed down in July. Market participants cited renewed geopolitical tensions in West Asia, which have pushed up crude oil prices as a key factor dampening overseas buying sentiment and narrowing interest rate differential between US and India. FPI inflows into government securities under FAR fell sharply to Rs 7,602 crore in July from record inflows of Rs 41,773 crore in June, according to data from the Clearing Corporation of India . Inflows in June were driven by a combination of Reserve Bank of India (RBI) measures and heightened expectations that India would soon be included in the Bloomberg Global Aggregate Index after the government scrapped capital gains tax on foreign holdings of sovereign debt. FPI holdings in G-Secs stood at Rs 3.73 lakh crore as of July 31. “Global uncertainties, fluctuating crude oil prices, and a number of central bank policy decisions have collectively contributed to a cautious market sentiment in recent weeks. This caution has likely led to a moderation in FPI inflows into Indian government bonds, with investors adopting a wait-and-watch approach ahead of next week’s RBI policy announcement,” said Sameer Karyatt, executive director and head of trading at DBS Bank India. Oil prices climbed back to $100 a barrel on July 23, the highest level in two months. It rose about 23% to $89.5 in July. The spike in crude costs pressured the rupee , which weakened as much as 2% to 96.57 against the dollar in July before recovering some ground. On Friday, it ended at 95.39. He added that, additionally, market participants have been closely monitoring developments regarding the potential inclusion of Indian government bonds in the Bloomberg Global Aggregate Index. “In the absence of definitive clarity on this front, investors are continuing to adopt a cautious stance as they assess the evolving macroeconomic landscape.” Market participants also attributed the slowdown in inflows to a narrowing yield differential between the US and India, which has reduced the relative appeal of Indian bonds. The spread has fallen by 68 basis points over the last four months. “Rising US Treasury yields in recent weeks have narrowed US-India yield spreads. The rupee depreciation reduces the effective return in dollar terms. Together, these factors are expected to moderate the pace of foreign inflows into Indian government bonds,” said Guara Sengupta, chief economist, IDFC FIRST Bank.