Foreign investors have stepped up buying of Indian government bonds in the last four sessions, after weaker-than-expected economic growth data last week spurred expectations of monetary policy easing by the central bank.
These investors net bought bonds worth over Rs 90 billion ($1.06 billion) under the Fully Accessible Route till Wednesday, a majority of which are part of JPMorgan's debt index, data from Clearing Corporation of India showed.
Foreign investors heavily sold bonds for most of November, as U.S. yields remained elevated after Donald Trump's victory in the presidential election raised doubts about the Federal Reserve's easing cycle.
At one point, net selling in FAR bonds had crossed Rs 100 billion.
"I believe market is looking at bonds favorably given expectations of monetary policy easing, which has likely helped inflows," said Dhiraj Nim, an economist and FX rates strategist at ANZ.
The Reserve Bank of India's (RBI) policy decision is due on Friday.
The 10-year bond yield has fallen to three-year lows and the spread with the repo rate has declined to a 7-year low since the GDP data on Friday, indicating that some form of monetary easing is likely.
Most market participants expect the RBI to ease monetary conditions by lowering banks' cash reserve ratio (CRR) from 4.5% currently, with only a few seeing an outright interest rate cut.
A CRR cut of 50 basis points would free up around 1.1 trillion rupees in the banking system and spur demand for bonds.
"I am in the rate cut camp for tomorrow's meeting. I believe there are serious downside risks to growth, even if it is a cyclical slowdown and the economy is already in a negative output gap," Nim said.
"The weak growth data likely signals economic slack, leading foreign investors and banks to anticipate that the RBI may pause or cut rates sooner than expected to support growth," said Manish Bhargava, CEO at Straits Investment Management.
While some of the demand for bonds may be driven by rate cut expectations, yields are considered attractive and the rupee has seen the lowest depreciation among emerging market currencies in recent weeks.
"India's relatively high yields continue to offer an attractive carry trade opportunity," Bhargava said.
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