Foreign funds flee India's bonds just when it needs them the most

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 huge borrowing plan.

The amount of sovereign securities held by global funds has slumped Rs 76,700 crore ($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 per cent 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 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 Rs 1.1 trillion or less than 2 per cent 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 Rs 22 trillion 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 3.90 per cent, while the one-year government bond yields 3.88 per cent.

The RBI’s surprise 40 bps rate cut last week has reduced the appeal of Indian debt and the prospect of further increase in government borrowing remains high. bloomberg