US bond tapering impact may hurt India, Indonesia less than other nations

Sovereign bonds from India and Indonesia are seen better placed to weather the impact of rising U.S. yields thanks to their wider rate differential over Treasuries.  
 

Bonds from the two countries are already leading gains in emerging Asia this quarter, offering 3%-5% returns to dollar-based investors. In comparison, lower-yielding bonds from Thailand and South Korea have handed losses of between 4.5-5%.

The Treasury rout spurred by the Federal Reserve’s indication that it may start tapering bond purchases in November has intensified amid challenges faced by President Joe Biden’s administration in raising the debt ceiling. The wave of global bond selloff that ensued has weighed on Asian bonds, with hawkish comments from U.K. and Norway’s central bank adding to jitters.

Indonesia and India’s bonds have outperformed due to their wider spread over Treasuries, softer inflation prints relative to emerging-market peers, positive fiscal developments and the central bank’s bond purchases, said Siddharth Mathur, head of emerging-market research for Asia Pacific at BNP Paribas SA. “We expect these trends to remain intact into the end of the year.” 

The 10-year bonds from the two nations have a buffer of around 470 basis points each over similar-maturity Treasuries. Despite the recent moves, the gap is near a five-year average for rupee bonds while it has tightened from a mean of 515 basis points for rupiah debt. The premium offered by won and baht bonds is around 70 basis points or lower on similar notes, making them more vulnerable to Treasury swings.  

Indonesia pledged to return the budget shortfall to below 3% of gross domestic product by 2023, while India this week stuck to its borrowing plan for the second half of the fiscal year ending in March 2022. A potential inclusion in global bond indexes is seen as another positive catalyst for Indian bonds.

Foreign funds poured $3.3 billion into Indian bonds in the three months ending September, the most since the third quarter of 2017. Rupiah bonds saw a net outflow over the same period but robust onshore demand, following a reduction in debt supply, and Bank Indonesia’s purchases have kept yields anchored. 

Risks Ahead
 

Rupee bonds face the risk that the Reserve Bank of India may tighten its policy soon. The central bank drained cash from the banking system at a sharply higher rate Tuesday after making its bond purchase program liquidity-neutral since last week.

Macro risk from a hawkish Fed still persists for rupiah debt given that nearly 22% of the nation’s sovereign bonds are held by foreign investors. While that proportion has fallen from as much as 39% in January 2020, it’s still one of the highest among Asian nations. 

--With assistance from Ronojoy Mazumdar.