Foreigners flee India’s bond market just when it needs them most

By Kartik Goyal

Foreign funds have slashed their holdings of India’s government bonds to the lowest in three years amid dwindling returns, just as the nation embarks on a mammoth borrowing plan.

The amount of sovereign securities held by global funds has slumped 767 billion rupees ($10 billion) from this year’s peak in February as steep hedging costs diminished pay-offs in one of Asia’s highest-yielding markets. The rupee’s plunge by about 6% in 2020 further reduced the appeal of Indian debt.

“While the dollar cost of funding has come down for overseas investors, the cost of hedging foreign currency risk has stayed stubbornly high,” said Harihar Krishnamoorthy, treasurer at FirstRand Bank Ltd in Mumbai. “On a fully hedged basis, the spreads on government bonds could even be negative for short term paper, thus appetite from foreign investors is going to be lackluster.”


Foreigners hold about 1.1 trillion rupees or less than 2% of India’s total outstanding debt. While Prime Minister Narendra Modi’s government has taken steps to bring in more overseas buyers to soak up its record 22 trillion rupees of central and state government debt, foreigners have found few incentives to buy.

Returns after accounting for hedging costs are slim, even before considering funding expenses. For example, onshore hedging cost, as measured by the rupee’s one-year forward-implied yields is at 3.85%, while the one-year government bond yields 3.89%.

The Reserve Bank of India’s surprise 40 basis points rate cut last week has reduced the appeal of Indian debt and the prospect of further increase in government borrowing remains high as Asia’s third-biggest economy is seen contracting in the fiscal year through March 2021.

“The FX hedging costs for investments in Indian bonds, with implied yields around 5-7%, are relatively higher than those of most regional peers,” said Prashant Singh, senior emerging-market debt portfolio manager at Neuberger Berman Singapore Pte. Concerns over a widening deficit and a credit rating downgrade are also prompting outflows, he said.


Outflows from India’s government and corporate notes totaled $13.7 billion this year, amid a sell-off in emerging markets, which sent the rupee to a record low of 76.9088 against the dollar in April. While the currency has posted a modest recovery since, it’s still among Asia’s worst performers.

“Investors assess currency risk and hedging costs. If your currency is depreciating and hedging costs are high then that will obviously make it difficult to hold positions,” said Kenneth Akintewe, head of Asian sovereign debt at Aberdeen Standard Investments in Singapore.


Given that Indian bonds aren’t part of the global bond indexes, investments “remain largely off-benchmark trades for global investors,” said Karan Talwar, senior investment specialist for emerging-market debt at BNP Paribas Asset Management in Hong Kong.

South Korean bonds have seen the biggest foreign inflow this year with $27 billion of purchases, followed by $7.6 billion into China, according to data compiled by Bloomberg.