FIIs seen regaining faith in govt bonds in January

Bank of Baroda first bank to raise dollar debt of $750 million during the month, gets orders worth $4.4 billion from banks and fund managers

After pulling out $14 billion between May and December 2013, foreign institutional investors (FIIs) are returning to the Indian debt market. Soon after the US Federal Reserve announced it intended to taper its stimulus package in May last year, foreign investors began selling Indian bonds, as India’s external condition looked precarious. This sell-off led to the rupee going into a free fall.

Between May 21, 2013, and January 1 this year, FIIs have been net sellers of Indian bonds. On May 21, 2013, FII investment in Indian bonds hit a high of $38.52 billion; this fell to $24.95 billion on January 1, 2014. With the currency stabilising and the government getting a grip on the country’s recalcitrant current account deficit, foreign investor interest in Indian bonds has revived. This is true for government, as well as corporate bonds.

Since the beginning of this month, net FII investment in the debt market has risen by $2 billion, with fresh inflows into Indian bonds. FIIs claim Indian debt has turned attractive again, as bond yields are high and the forward premia, or hedging cost, has also declined from the highs touched in August.

Neeraj Gambhir, managing director and head of fixed income at Nomura, says: “Now, it is remunerative to invest in Indian bonds for long-term investors such as asset managers, sovereign wealth funds and central banks. Through the last month or so, there has been a reversal in investor interest in the bond market. This is long-term money that is relatively more stable. Though the hedging cost has come down, it continues to be a deterrent. If the cost were to come down further, we will see some more flows.”

Demand is back not just for government bonds, but also debt paper issued by Indian companies and banks. Bank of Baroda is the first Indian bank to raise dollar debt of $750 million from global banks and fund managers. On Wednesday, the bank’s joint lead managers, Barclays, Standard Chartered Bank and Citibank, closed a bond issue of $750 million. The debt, raised for five and a half years, was priced 325 basis points above the five-year US Treasury, implying a yield of 4.92 per cent. The final order book attracted orders worth $4.4 billion from 300 foreign investors. Bankers say this implies a return of appetite for the Indian paper and through the year, many more banks will raise relatively cheaper foreign debt to reduce the cost of funds.

It is expected FIIs will continue to pump money into Indian debt in the coming months. While it is unlikely all the $14 billion will return to Indian debt, some may definitely do so. And, if forward premia falls further, a lot more FII money may come into the Indian debt market.