Bond market: As rupee falls, RBI weighs threat to securities on Bond Street

The recent slowdown of foreign investment in so-called fully affordable government bonds has caught the attention of the Reserve Bank of India (driven), which has been conducting market research on the impact of global volatility on local debt markets amid pressures on the rupeeThe exchange rate.

Officials from the RBI’s Financial Markets Regulatory Department (FMRD) have informally spoken to banks, particularly foreign lenders, to assess liquidation of foreign trading positions in Indian debt marketsincluding those taken on certain interest rate derivatives, people aware of the matter told ET.

“FMRD officials make periodic calls to bond market “Participants assessed market developments and over the past few days the focus has been on outflows of FAR (fully accessible route) securities at a time when heavy capital outflows due to global turmoil have put pressure on the rupee” said a source.

TRS Positions of Banks
“They have been asking foreign banks about liquidating TRS (total return swap) positions as part of the flows that came to the market in the pre-crisis period. JPMorgan Index The inclusion was made through the TRS instrument, which is used as an indicator to take exposure to local bonds,” the person said.

The FAR category of government securities, introduced by the RBI in March 2020, has no restrictions on overseas investment. Only FAR category bonds are eligible for inclusion in the JP Morgan index.

Of the around $10 billion of foreign investment that flowed into Indian debt between September 2023 and June 2024, foreign bankers estimated that 20-25% was through TRS instruments. JP Morgan announced the inclusion of India in its emerging market bond index in September 2023. The RBI did not respond to queries.BONDS LOSE APPEAL
After three months of strong foreign portfolio investment flows into Indian FAR bonds, the pace of overseas buying came to an abrupt halt this month, with last week marking the first weekly outflow since domestic bonds were included in the JP index Morgan on June 28. Meanwhile, foreign portfolio investors (FPIs) have sold $8 billion worth of local stocks so far this month, deposit data showed. In the week ended October 11, the indicative value of FPI’s aggregate holding in FAR bonds fell by ₹1,675.25 crore to ₹2.48 lakh crore, Clearing Corporation of India data showed. Between September 30 and October 15, FPI’s FAR bond holdings increased by only Rs 47.5 crore, a much smaller increase than the previous three months. As on October 15, FPI’s holding of FAR bonds was ₹2.47 lakh crore.

In July, the value of FPI holdings in FAR bonds increased by Rs 21,033 crore, followed by an increase of Rs 23,914 crore in August and Rs 17,971 crore in September, the data showed.

For FPI’s monthly flows into FA R bonds to match the rate of between $2 billion and $2.5 billion over the past three months, the pace of investment would have to increase dramatically over the 11 trading days left in October.

“There were strong discretionary flows that occurred in the run-up to index inclusion,” one expert said. “Market participants have conveyed to the RBI that given the rise in US bond yields this month and volatility in oil prices, some of the discretionary overweight positions may be unwinding.”

FPI’s waning interest is due to unfavorable global factors, including lower expectations of U.S. rate cuts, strong volatility in crude oil prices amid escalating violence in West Asia, and market swings triggered by efforts of China to boost its weakened economy.

On Friday, the rupee weakened beyond the psychologically significant mark of 84 per dollar for the first time in the domestic market, as international headwinds sparked a global rush to the safety of the US currency.

Additionally, better-than-expected US data has led global investors to temper earlier expectations of aggressive rate cuts by the Federal Reserve in the coming months. This has pushed up 10-year US Treasury yields by a substantial 22 basis points so far this month. Higher US bond yields reduce the attractiveness of fixed income assets in emerging markets such as India.

While foreign flows of FAR bonds have slowed this month, some degree of recovery could come by the end of the month as India’s weight in the JP Morgan index is set to rise 1% each month until March 2025 .