Foreign Investors Shift to Short India Debt Ahead of Policy Shift

Indian Government Bonds Attract Overseas Investors Amid Interest Rate Cycle Expectations

Overseas investors are increasingly opting for short-term Indian government bonds as they find attractive entry points amid expectations of the interest rates cycle turning. The Iran war has driven inflation higher, prompting investors to seek refuge in bonds with maturities of less than five years. Data from clearing houses shows that such bonds made up over two-thirds of the top 10 notes foreign investors bought during March-May, a significant increase from less than half of similar purchases in January-February.

Foreign Investor Purchases in Indian Government Bonds

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Indian government bond yields have risen over the last three months, with shorter duration yields spiking on inflation concerns due to the Iran war-linked energy shock. The 10-year benchmark bond yield rose 34 basis points from March to May, while the five-year yield rose 55 basis points, with the spread dropping to an eight-month low of 15 basis points. This shift in yields has created a valuations-driven opportunity for foreign investors to buy short-end bonds.

Investors are increasingly factoring a shift toward tighter policy, said Krishna Bhimavarapu, APAC economist at State Street Investment Management. While the Reserve Bank of India is widely expected to hold rates at the June meeting, the policy direction is clearly shifting. In such an environment, the front end of the yield curve offers more attractive risk-adjusted carry with lower duration risk, while the long end remains vulnerable to further repricing if the tightening cycle materialises.

The RBI rate decision is due on Friday, with most economists expecting status quo, while Standard Chartered Bank has called for a 25-bp hike. Nagaraj Kulkarni, chief rates strategist - South Asia & Indonesia and head - flows strategy at the foreign bank, notes that the curve has bear flattened with short-end yields rising more than the long-end yields. This has created a valuations-driven opportunity for foreign investors to buy short-end bonds.