Ahead of Budget 2020, FPIs reduce bond exposure on unfavourable cues

There is fear that the RBI has no wiggle room for further rate cuts. Without rate support, yields will rise. This translates into a fall in prices for bonds

Ahead of the Union Budget on February 1, foreign investors are busy liquidating their debt holdings, particularly in government securities.

There is fear of massive borrowing in the Budget, which the bond market expects to be at least Rs 7.5 trillion, from the Rs 7 trillion planned for 2019-20.

There is also the fear that the Reserve Bank of India (RBI) has no wiggle room for further rate cuts. Without rate support, yields will rise. This translates into a fall in prices for bonds. The investors, therefore, are cashing in before yields jump on unfavourable Budget numbers, say bond dealers.

In January so far, foreign portfolio investors (FPIs) have net sold $1.56 billion. In November, FPIs had sold $442 million. In December, foreign investors had sold $756 million. At the start of the month, FPIs had exhausted more than 75 per cent of their limits in government bonds. But as of Tuesday, they had brought it down to 71 per cent, the data showed.

The 10-year bond yields closed at 6.64 per cent, up from the 6.50-per cent levels in end-December, when the RBI started doing its special open market operations (OMOs), where it sold short-term bonds and bought long term to bring down long-term yields.

Before such a special OMO announcement, the 10-year bond yields had touched 6.75 per cent. Since then, the RBI has done four special OMOs. Therefore, the recent rise in yields, despite the special OMOs, has brought some worries to investors. More importantly, what the future holds for the bond market would largely depend on how long the RBI can continue to provide such special OMO support.

“The market is awaiting further clarity on the Budget numbers, and may also wait it out to see how much support the RBI can provide,” said Jayesh Mehta, head of treasury, Bank of America.

The RBI has reduced its policy rate by 135 basis points before pausing in the December policy. The scope for such cuts is limited, even as one more cut can be expected in the April policy. In between, the fiscal deficit of the government is expected to be at least 3.8 per cent of gross domestic product, from the 3.3 per cent projected earlier, say bond traders.

“Investors are sanguine about the fiscal glide path and the impact it has on the government borrowing programme. Moreover, with surge in inflation, the bar for additional monetary easing from the RBI is high. Hence, FPIs seem to be somewhat defensive on debt flows,” said B Prasanna, head of global markets and proprietary trading group, ICICI Bank.

However, the RBI’s need for rate cuts could also be curtailed if the Indian economy recovers from its decade lows.

“Global growth is doing satisfactory. With India’s growth story being service-led, it will also stabilise in the coming months. Whether there will be need for more rate cuts in such an environment needs to be seen,” said Mehta.

The liquidation from the bond market doesn’t mean foreign investors are losing interest in India. They continue to remain positive on the equities segment.

If in rupee terms, the outflow from debt has been Rs 11,136 crore, the inflow into equities has been close to Rs 12,000 crore, noted Prasanna.

“There has been a shift seen in foreign institutional investment allocation from debt to equities. A part of it can be attributed to growth deceleration bottoming out in India, as evidenced from some of the recent high frequency indicators. In this context, equities may be a preferred asset class on the margin,” said Prasanna.