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Indian government bonds losing their sheen with foreign investors

FIIs have sold Rs 11,300 cr worth of bonds in India for ten trading days beginning May 22, the first time since they were allowed to buy fixed income securities in 1998.

, ET Bureau|
Jun 05, 2013, 10.50 PM IST
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MUMBAI: It may be the beginning of the end of overseas fund flows into Indian Rupee debt, at least for now, with global funds selling bonds for ten days on the trot as the higher Indian yield advantage vanishes.

Indian bonds which attracted record overseas funds because of their high yields are losing their sheen as a rise in yields in the US makes it profitable to buy US bonds rather than Indian government bonds. In fact, the falling yields of Indian bonds have added to the negative outlook for fund flows

Foreign Institutional Investors have sold Rs 11,300 crores worth of bonds in India for ten trading days beginning May 22, the first time since they were allowed to buy fixed income securities in 1998, data from the Securities Exchange Board of India shows.

"There is definitely a problem in the (Indian) debt markets," said Raj Kothari, fixed income trader with London based Sun Global Investments, "Most people are on the sidelines now."

Global money markets are in turmoil after the Federal Reserve chairman Ben Bernanke last month said that the record stimulus in place since 2008 may taper off. With economic growth beginning to take route, the US Fed may reduce the stimulus to prevent inflation getting out of control once demand accelerates.

In May alone yields on ten year US treasuries jumped by 56 basis points from 1.6% to 2.15%, Bloomberg data shows. A basis point is 0.01 percentage points. Whereas yields on ten year benchmark Indian government bonds have fallen from 8.3% in June last year to 7.13 as on May 30. A similar trend has been seen in the case of Indian corporate bonds as well. Bond yields and prices move in opposite direction.

With this movement in bond yields, the gab between the US treasury and India G-Secs have narrowed from nearly 7 percentage points, to just about 5 percentage points.

Global investors who bring in US dollars into India usually hedge against currency movements. With hedging cost at about 6.5%, an international investor buying Indian bonds will end up losing money. A 2.2% return in US dollars is a more preferred option for FIIs.

"A 30 year Indian government paper gives me 8.3% in rupee, while a dollar bond issued by an Indonesian company can give me more than 7% which has a stable rating and I do not even need to hedge," Kothari said, "So why should I put money in the Indian paper, where even the hedging cost is on the rise?"

The Reserve Bank of India has cut key interest rates by almost 125 basis points since April last year and faltering economic growth may push the central bank to cut rates further in this fiscal year.

Economists at Deutsche Bank and Barclays expect rate cuts to accelerate this year as inflation continues to be at acceptable levels which may further dent the attractiveness of Indian bonds.

The RBI has to concede that inflation worries are dissipating rapidly, at least for the duration of this year,'' said Taimur Baig at Deutsche Bank. The central bank will be compelled to cut rates by data developments.''

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