FIIs in Debt

Why have FIIs been net sellers in debt in October?

For the month of October FPIs have sold over $700 million of bonds on a net basis. There are 3 things that you need to understand at the very outset. Firstly, $700 million is not really a big number to get worried about. Secondly, FPIs are close to their limits on Indian G-Sec debt and the leeway is limited as of now. Lastly, FPIs anyways tend to lighten positions in emerging market debt in the last quarter due to a plethora of macro risks. Having said that, it is essential to understand 3 factors that are driving debt selling…

Example of risk-off trading… 

Global investors typically tend to get risk-off ahead of any major rate hike prospects in the US. A rate hike is bad for bonds and EM bonds are especially more vulnerable. FPIs, therefore, prefer to sell out of emerging markets and re-allocate to developed market debt. With the probability of a rate hike in December having gone up sharply to 74%, the trend is likely to be more risk-off in Indian markets. We saw in 2013 how a risk off trade led to nearly $14 billion worth of FPI debt money flowing out. These risk-off trades are the most likely explanation for FPIs selling out of Indian debt.

Rate cuts factored in… 

The RBI has cut repo rates by 175 basis points since January 2015 and is on the verge of another rate cut in its February 2017 monetary policy. Unfortunately, if you look at the 10-year G-Sec yield over the last quarter, the yields have fallen by nearly 200 basis points. That means; the 50-75 bps cut in rates by the RBI is already factored into bond markets leaving little scope for any bond price appreciation. That is also leading to FPIs selling out of Indian bonds and shifting to other asset classes.

Lower dollar gains on debt…

One of the key worries for FPIs is the falling yield on government debt. The yields have suddenly fallen in the last 3 months by over 200 basis points. That means fresh investments in Indian debt will not be too attractive. One also needs to look at it in terms of dollar returns. With the INR quoting at an unfavorable real effective exchange rate (REER), devaluation of the rupee is long overdue. In addition, the $22 billion payout on account of FCNR payouts will also add to pressure on the rupee. It is highly likely that the INR may cross the 70/$ mark in the next quarter and that will heavily dent dollar returns on debt. The Indian government is also not too keen to stop the rupee from depreciating as they also want to protect the interest of Indian exporters.

FPI selling in debt is not a one-off event but a sign of things to come. One can expect the debt selling trend to get accentuated in the days to come. FPIs may continue to shun Indian debt! ©

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