Foreign investors are making a strong comeback to Indian bonds following an April sell-off, ahead of the debt’s inclusion into a major global index at the end of the month.

Since September, net inflows have surged to $10 billion. This follows JPMorgan Chase & Co.’s announcement of the inclusion, effective June 28. From June 1 to June 18, global funds bought a net 73.5 billion rupees ($881 million) in index-eligible debt. This follows May’s purchase of about 52 billion rupees, contrasting with April’s selloff of 98.3 billion rupees in Fully Accessible Route bonds.

The formation of a coalition government by Prime Minister Narendra Modi has contributed to cooling yields after a closely contested election. A robust dividend payment from the central bank to the government ahead of the annual budget is adding positive momentum. The 10-year government bond yield has decreased by eight basis points to 6.98%, reflecting investor confidence.

Further, Bloomberg Index Services Ltd. will include select Indian bonds in its emerging market local currency index starting next year, further boosting investor interest.

This resurgence in foreign investment highlights the growing confidence in Indian bonds, driven by global index inclusions and favorable political developments.

April 2024 saw a significant increase in foreign investor selling of Indian government bonds, marking the highest monthly outflow since the COVID-19 pandemic. However, market experts believe this is a temporary trend and inflows are likely to resume in the coming months.

The recent selling activity can be attributed to two main factors:

1. Weakening rupee: A decline in the value of the Indian rupee (INR) makes investing in Indian bonds less attractive for foreign investors.
2. Rising US yields: An increase in US bond yields offers a more competitive return for investors, drawing them away from emerging markets like India.

Experts remain optimistic on long-term prospects

Despite the recent outflows, analysts remain confident in the long-term outlook for Indian government bonds. Here’s why:

1. Limited impact of rupee weakness: Experts believe the recent depreciation of the rupee is unlikely to be a long-term trend.
2. India’s lower correlation with US yields: Compared to other emerging markets, India’s bond yields show a lower correlation with US yields, making them a more stable investment option.
3. Attractive carry trade: Indian bonds still offer an attractive carry trade opportunity, where investors can benefit from the difference between higher Indian yields and lower hedging costs.
4. Positive macroeconomic fundamentals: India’s strong economic growth and improving fiscal situation make its bond market appealing to foreign investors.

Predictions for future inflows

Market participants anticipate a return of foreign inflows into Indian government bonds.  Experts project inflows ranging from $20 billion to $30 billion, driven by:

1. Index tracking funds: Many index tracking funds are yet to invest their allocated amounts in Indian bonds.
2. Favorable carry trade: The significant difference between Indian and US yields continues to attract investors.
3. Stable currency and positive macroeconomic outlook: India’s economic stability and positive growth prospects are positive signs for bond investors.

Overall, while there was a temporary increase in foreign investor selling of Indian government bonds in April 2024, experts believe this is an aberration. Strong underlying fundamentals and attractive investment opportunities are expected to bring foreign investors back to the Indian bond market in the coming months.