Narrowing India-US interest rate differential drives FPIs to pull out money from G-secs

Bonds

Narrowing of interest rate differential between India and the US has prompted foreign portfolio investors (FPI) to pull out money from government securities through the Fully Accessible Route (FAR), despite the US Federal Reserve lowering the policy rates in September.

The interest rate differential narrowed in the last few days because the yield on US treasury has risen sharply over robust economic data and deficit worries. Indian bond yields, on the other hand, have remained range-bound.

According to the Clearing Corporation of India (CCIL) data, FPI investment in government securities under FAR route reduced to Rs 2.44 lakh crore as on October 29, as compared to Rs 2.50 lakh crore on October 1.

“US Treasury yields have jumped sharply, but Indian bond yields remain almost stable, which narrows the spread between India and the US. Also, the Indian rupee has been under pressure, all these conditions are generally considered as not so favourable for FPIs for any incremental allocations into government bond market,” said Mataprasad Pandey, vice-president of Arete Capital Service.

In the last few days, especially after the rate cut by the US Fed, yield on US Treasury papers has gone up by 58 basis points (bps) amid concerns over macroeconomic fundamentals. In addition, there are worries that the US Fed may be less inclined to cut rates, even though there is expectation of another 50 bps rate cut. This led to a sharp rise in yield in the US, which led foreign investors to pull out money from emerging markets.

Usually, whenever there is an uptick in the US Treasury yield and volatility in the rupee, FPIs pull out money from the Indian markets and invest in the home country.

The FPI flows remained strong in government securities under FAR route, especially after the initial bond inclusion announcement by JP Morgan in their global bond index. Experts said that this flow is expected to reverse in the coming months after the inclusion of Indian bonds in another two bond indices.