Global Investors Pull Money Out of Indian Bonds: What It Means for India’s Debt Market

In a significant development, global investors have started to withdraw money from Indian bonds this month, raising concerns about the stability and attractiveness of the nation’s debt market for global investors. During the current month, foreign investors have pulled out more than ₹ 5000 crore from Indian bonds. As per reports, Foreign Institutional Investors (FIIs) were net sellers in the Indian debt market every week during the current month.

This shift is particularly noticeable in the Fully Accessible Route (FAR) bonds—a category of Indian debt specifically designed to attract foreign investments, as these bonds have no restrictions on foreign ownership. FAR bonds have seen foreign outflows of about ₹ 4000 crore so far this month.

This marks the largest outflow since May 2024. The message is clear that overseas investors are cooling on Indian debt. But what exactly is driving this change? And what implications does this have for the Indian bond market, especially for retail and domestic investors?

The Significance of Fully Accessible Route (FAR) Bonds:

The Fully Accessible Route bonds are part of India’s strategic push to integrate its bond market with global financial markets. First introduced in 2020, FAR bonds are a special class of government securities (G-Secs) that allow unrestricted participation by non-residents. This initiative was designed to boost foreign portfolio investments in Indian debt instruments and make the Indian bond market more liquid, thereby reducing borrowing costs for the government and corporations.

For the past few years, FAR bonds have seen healthy participation from foreign institutional investors (FIIs). The expectation was that India’s inclusion in global bond indexes like the JP Morgan GBI-EM or Bloomberg Global Aggregate Index would create a steady flow of overseas investments.

However, recent outflows from these bonds indicate a significant change in investor sentiment. While India remains on track for eventual inclusion in global bond indexes, the short-term factors driving withdrawals deserve a closer look.

Key Drivers behind the Recent Outflows:

1. Rising Global Bond Yields: One of the primary reasons for the recent pullback in Indian bonds is the rise in bond yields across developed markets. With the US Federal Reserve maintaining a relatively hawkish stance on monetary policy despite last month’s rate cut, as well as concerns about inflation, debt, and rate expectations, the US Treasury yields are rising. In comparison, Indian bonds, while still yielding high returns, are losing their relative appeal somewhat in terms of risk-adjusted returns.
2. RBI’s Reluctance to Cut Rates: Another factor contributing to foreign investors’ concerns is the Reserve Bank of India’s (RBI) reluctance to follow global central banks in cutting rates. While many central banks are signaling rate cuts to stimulate growth and combat potential economic slowdowns, the RBI has maintained a cautious approach. In its recent meetings, RBI has made it clear that inflationary concerns remain paramount, restraining it from lowering rates in line with other major economies. This divergence in monetary policy has somewhat reduced the attractiveness of India’s bond market, pushing foreign investors to explore better opportunities elsewhere.
3. Expectations of Federal Reserve Rate Cuts Boosting the Dollar: Another global factor impacting foreign investment in Indian bonds is the growing expectation that the US Federal Reserve may announce another rate cut this year following the rate cut of last month. While the Fed has been aggressive in its monetary tightening over the past year, signs of a slowing US economy and moderating inflation could lead to another rate cut. This has caused a surge in demand for US assets, boosting the dollar and making Indian bonds, which are denominated in rupees, less attractive. As investors anticipate future Fed rate cuts, they prefer to invest in US bonds and dollar-denominated assets to take advantage of a strengthening dollar.
4. Profit Booking by Investors: Indian bonds have been one of the best-performing debt assets in Asia this year, delivering returns of almost 8%. While this has been a boon for investors so far, it has also prompted some to lock in profits. With bond prices rising in response to higher demand earlier in the year, many global funds see this as an opportune time to book profits, especially given the uncertain macroeconomic environment. For investors who bought Indian bonds at lower yields, the recent rally offers a chance to exit with gains, further contributing to the outflows.
5. Inflationary Concerns in India: Domestic inflationary pressures have also played a role in the exodus of foreign investors. The core inflation remains sticky, and the retail inflation, especially food inflation continues to rise, casting doubt over the trajectory of price stability in the near term. High inflation reduces the real returns on fixed-income securities, making Indian bonds less attractive for foreign investors seeking higher real yields. Furthermore, concerns that the RBI might have to tighten monetary policy if inflation persists have added to the uncertainty surrounding Indian bonds.
6. Currency Volatility and Rupee Depreciation: The Indian rupee has been under significant pressure due to rising oil prices, a strengthening US dollar, and India’s widening current account deficit. For foreign investors, a weakening rupee adds a layer of currency risk that may erode the returns on Indian bonds. While bond yields might remain attractive in local currency terms, any depreciation of the rupee against the dollar could partially negate those gains when funds are repatriated to foreign currencies. The fear of further currency volatility is one of the key reasons why investors are pulling out of Indian debt instruments.
7. Global Economic Slowdown: Global economic conditions have also weighed heavily on emerging markets like India. With major economies experiencing slowdowns, investors are adopting a risk-off approach, moving away from emerging market assets and focusing on safer investments in developed markets. This shift in sentiment is especially pronounced in bonds, as investors seek stability in times of economic uncertainty.
8. Increasing Attractiveness of Chinese Assets: Foreign Portfolio Investors (FPIs) recently shifting their funds from the Indian bond and equity markets, are redirecting capital toward several other global opportunities. A significant portion of these funds is flowing into Chinese markets, which have rebounded due to China’s economic recovery and favorable government policies, making Chinese assets attractive on a valuation basis.
9. Other Global Factors: Geopolitical uncertainties, especially tensions in the Middle East, have prompted a risk-averse approach among FPIs, influencing them to seek markets perceived as safer or with better growth prospects outside India. The rise in crude oil prices also raises inflation concerns, which may have deterred investment in emerging markets like India. In terms of sectors, FPI inflows are expected to focus on U.S. and European assets with more stable returns, especially as these economies show more resilience against current global volatility​

The Role of Domestic Institutional Investors (DIIs):

Amidst this global sell-off, domestic institutional investors (DIIs) have played a crucial role in maintaining liquidity and stability in the Indian bond market. DIIs, comprising mutual funds, insurance companies, and pension funds, have stepped in to absorb the outflows from foreign investors. They are supported by steady inflows from retail investors into domestic mutual funds and insurance products.

Indian DIIs view government securities (G-Secs) as safe, long-term assets, suitable for matching their liabilities. With the RBI maintaining a relatively stable policy stance, DIIs remain confident in Indian bonds, using this as an opportunity to accumulate high-quality debt securities at attractive yields.

The growing financial literacy among retail investors in India has also led to increased interest in fixed-income assets. As foreign investors retreat, DIIs are poised to continue playing a stabilizing role in the market, keeping bond prices from falling too sharply.

What the Future Holds for the Indian Bond Market?

A) For Foreign Investors:

Despite the recent outflows, the long-term prospects for Indian bonds remain intact. The Indian bond market is among the largest and most liquid in emerging markets, and the eventual inclusion of Indian bonds in global indexes could bring substantial foreign inflows over the next few years. However, short term challenges, such as inflation, currency risks, and global economic uncertainties, will continue to impact foreign investor sentiment in the near term.

If global inflation begins to moderate and the US Federal Reserve embarks on further rate cuts, foreign investors might once again find Indian bonds appealing. The stabilization of the Indian rupee and an improvement in India’s fiscal and current account balances could further boost confidence in the nation’s debt market.

B) For Domestic Investors:

With foreign investors retreating as of now, the Indian bond market offers a good opportunity for domestic investors to step in. Yields are currently attractive, and as inflation starts to cool, with possible rate cuts, prices could see a rise, offering capital appreciation. Moreover, the Indian government’s continued focus on developing the domestic bond market provides a relatively stable outlook for local investors.

Retail investors, in particular, can benefit from investing in government bonds through platforms like the RBI Retail Direct scheme, which offers direct access to government securities with a low entry barrier. With the safety of G-Secs and the potential for attractive returns in a cooling inflation environment, bonds offer a safer alternative to equities for risk-averse investors.

The recent SEBI announcement of liquidity window for bond holders also makes new issues of corporate bonds quite attractive.

Implications for Retail Investors and Investment Strategy:

Retail investors often gravitate towards equities due to the allure of higher returns, but in a volatile stock market environment, bonds provide a much-needed cushion of stability. Government bonds are safe investments backed by the sovereign guarantee of the Indian government.

In recent years, the accessibility of bond investments has significantly improved, thanks to SEBI-registered online bond platforms such as Jiraaf. These platforms allow retail investors to easily explore and invest in bonds, offering a transparent and user-friendly way to access fixed-income products. Platforms like Jiraaf offer detailed insights into various bond offerings, helping investors make informed decisions based on yield, maturity, and risk profiles.

Retail investors should consider the following when investing in bonds:

• Diversification: Bonds should complement equities and other asset classes in a well-rounded portfolio, offering stability and income during volatile times.
• Monitoring Macroeconomic Trends: Investors should pay close attention to inflation data, interest rate policies, and global economic trends, as these factors directly influence bond prices.
• Taking Advantage of Attractive Yields: Current bond yields are favorable, making this a good time to invest, especially for those looking for long-term fixed-income exposure.
• Leveraging Bond Platforms: SEBI-registered platforms like Jiraaf provide easy access to a wide range of bond offerings, making the process of bond investing more convenient and transparent for retail investors.

Conclusion: The Road Ahead for Bond Investors

While the short-term outlook for Indian bonds may seem uncertain due to rising global yields, inflationary pressures, and currency volatility, the long-term prospects remain promising. Domestic institutional investors are stepping in to fill the gap left by foreign investors, and India’s eventual inclusion in global bond indexes could open the floodgates for foreign inflows.

For both retail and institutional investors, the key lies in understanding the changing landscape of the bond market, the cyclical nature of it and adapting strategies accordingly. With careful monitoring of economic indicators and a diversified approach, Indian bonds continue to offer attractive opportunities for income and stability in the years ahead.