Foreign banks lap up government bonds ahead of India's index inclusion

Foreign investors pumped in Rs 14,281 crore in domestic debt market in January

Foreign banks stepped up their purchases of Indian government bonds in January ahead of the country’s inclusion in global bond indices later this year.

According to bond market dealers, the rise in demand for dated securities among foreign banks is also because of forward rate agreements (FRA) with insurance companies.

“This is due to FRA demand; foreign banks write FRA agreements with insurance companies. As a result, they buy securities of 14 years and above, and they pay fixed rates in the swap market between 3-year and 5-year tenure. This has led to foreign banks taking a long position (buying) in the government security market,” said a dealer at a primary dealership.

FRAs are agreements that insurers enter into with banks to lock in rates on long-dated securities, helping them offer guaranteed returns to policyholders. Banks charge a margin to hold these bonds on their balance sheets until maturity. The yield on the 14-year and 50-year government bonds fell by 2 basis points and 7 basis points, respectively in the current month.

The central government introduced the 50-year tenor security in its borrowing calendar for the second half of the current financial year, which was a long-standing demand by life insurance companies, particularly Life Insurance Corporation of India.

Foreign banks have net bought Rs 31,906 crore worth of government securities in the current month as of Thursday, according to data shared by fixed-income dealers. They were the top net buyers for the last nine consecutive trading sessions.

Meanwhile, standalone primary dealers were the top net sellers in the same period. They net sold Rs 19,908 crore worth of government securities as of Thursday. Market participants said that foreign banks have been buying government securities also on behalf of foreign portfolio investors.

“One distinct point of the trading in January has been that the foreign banks have been the consistent buyers. Quite possibly, because of bond inclusion. This is a reflection of their own view as well as of their FPI clients,” said Vijay Sharma, senior executive vice-president at PNB Gilts.

State-owned banks sold the benchmark bond at a profit during the week, said dealers. Standalone primary dealers placed short bets on the bond, which further aided yields in the past week.

“Public sector banks were the prominent buyers when the benchmark yield was around 7.40 per cent, now they have been booking profit,” said a dealer at another state-owned bank. “PDs placed short bets, and they covered a part of it at auction today (Friday),” he added. The yield on the benchmark 10-year government bond rose 3 basis points during the week.

J P Morgan has included India in its flagship index GBI-EM Global Diversified index. India will join the index with 1 per cent in June. The weight will increase by 1 per cent each month until 10 per cent in April 2025. Additionally, Bloomberg Index Services Limited (BISL) has launched a consultation paper seeking feedback on the proposed inclusion of the India Fully Accessible Route (FAR) bonds in the Bloomberg Emerging Market (EM) Local Currency Index.

Foreign investors pumped Rs 14,281 crore into the domestic debt market in January. “FPIs are the natural clients of foreign banks, and there has been robust demand from them. The sellers have been a mix of all the segments because FPIs approach all the segments for bonds,” said a dealer at a state-owned bank.

FPIs net investments in the domestic debt market had surged in December, marking a 77-month high and representing the highest amount since July 2017.