Rising bond yields might attract more foreign investors in debt

10-year bond yield could rise to 9.25 per cent

Rising government bond yields could attract more flows from foreign institutional investors (FII). The yield on the 10-year benchmark government bond 8.83 per cent 2023 has already breached the nine-per cent mark. The Street believes in the worst-case scenario, it might even touch 9.25 per cent, with investors showing limited appetite for government securities in the Reserve Bank of India (RBI)'s auctions.

RBI wants to encourage long-term foreign flows as this would help reduce volatility in the rupee against the dollar. Of late, RBI has been absorbing foreign flows through state-run banks to boost the foreign exchange reserves, which rose to $5.04 billion for the week ended March 28 to $303.67 billion.

"Rising yields will help in attracting incremental foreign flows. These foreign investors will be those who are medium-term investors," said Badrish Kulhalli, head of fixed income at HDFC Life.

The yield on the 8.83 per cent 2023 ended at 9.07 per cent on Friday, compared with the previous close of 9.01 per cent. The yield ended at a level that was last seen on November 22 at 9.10 per cent.

Government bond dealers said if at all the yield touches 9.25 per cent, from there, it would see corrections.

  The first auction of the financial year devolved partially on primary dealers due to lack of appetite. The partial devolvement signals that there is a need for open market operation (OMO) purchases of government securities so that the auctions sail smoothly. However, RBI had said in the past that OMOs would be used as a liquidity management tool and not to influence yields.

To encourage long-term flows, RBI had earlier said that investment by foreign portfolio investors (FPI) in government securities would be allowed only in dated securities of residual maturity periods of at least a year. The existing investment in treasury bills (short-term papers) would be allowed to taper on maturity/sale, the central bank said. As the overall limit for FPI investment in government securities will remain unchanged at $30 billion, the investment limits vacated at the shorter end will be available at longer maturities.

To encourage longer-maturity flows, investment limits in treasury bills were capped at $5.5 billion in April 2013 for foreign investors, while that for long-term investors was increased by $5 billion in June.

"Foreign investors vacated quota, in treasury bills on maturity can certainly be used for investment in government securities. But for a longer-term investment call, these investors should have confidence in the economy, as well as the performance of the government. If a stable government is formed, we can see foreign flows coming in to government bonds," said Ashutosh Khajuria, president (treasury) at Federal Bank.

Government bond dealers believe this week, the yield on 8.83 per cent 2023 was likely to breach the 9.10-per cent level, given that on Friday, RBI will again hold an auction of bonds for a notified amount of Rs 16,000 crore.

The rupee might appreciate this week on the back of flows from foreign investors in domestic markets. However, it is also believed by the Street that RBI might not allow the rupee to appreciate significantly, to protect the interest of exporters. Currency dealers see the rupee trading in a broad range of 59.75-60.50 a dollar this week. The currency ended at 60.09 to a dollar on Friday, compared with the previous close of 60.18.