Some see worst of bond selling over, helping rupee

The 17-session sell-off seen in the bond markets due to unwinding by foreign institutional investors (FIIs) may be getting over, and this may provide a bolster to the rupee — that is the refrain on the Street.

FIIs have net sold bonds worth $4.1 billion in the last 17 sessions, in line with the trend in other emerging markets.

Talk of tapering in quantitative easing (QE) by the US Federal Reserve led to a rise in US treasury yields and debt outflows which weakened emerging market currencies, especially those with high current account deficit like India.

Neelkanth Mishra and Ravi Shankar, analysts with Credit Suisse, see the sell-off ending and believe its impact on the Indian economy is relatively low.

That’s because of India’s (relatively) closed debt markets. “Less than 5% of its bonds are foreign-owned, much lower than other emerging markets. This limits the impact on the broader economy: India’s yields have risen the least since the sell-off started. Also, with a lot of bond market selling behind us, unless a crisis emerges somewhere, a further exodus of capital is unlikely, except in the very near term,” they said in a note on Friday.

Although Mishra and Shankar presage further fall in emerging market bond prices, they do not expect major damage because the Fed is unlikely to stop buying bonds before the end of 2014.

Jahangir Aziz and Sajid Chinoy, economists at JP Morgan, say there could be a risk to the Indian economy if the recent FII outflows from equities extend because, contrary to other emerging markets, equity inflows dominate debt inflows in India due to regulatory restrictions.

“As such, the outstanding stock of FII holdings of domestic debt has grown materially and is now at around $35 billion. Consequently, changes in debt flows, especially if they occur over a short period of time, begins to matter. While this may not have raised too much concern before, with equity inflows slowing down and trade deficit still large, the debt outflow became a material factor in driving down the rupee,” Aziz and Chinoy wrote on Friday.

Mishra and Shankar, however, do not see current situation warranting major equity outflows.

“India would still be badly impacted if capital flows to emerging markets slow down structurally — mainly through the currency, given the precarious balance of payments situation. But past episodes of FII equity investors’ net selling coincided with global crises.

While the moves in currencies and bond yields may be reminiscent of such trends, there isn’t yet any impending problem of a bank blowing up, a currency union dissolving, or an emerging market declaring bankruptcy,” they said.

Rohini Malkani, economist and managing director at Citigroup Global Markets, is more or less on the same page.

“The impact on India could be muted by a further drop in commodity prices which, in turn, could lead to lower current account deficit and also because of continued expansionary monetary policy by the Bank of Japan and the European Central Bank,” she recently said.

Rajesh Cheruvu, chief investment officer at RBS Private Banking, believes the bond sell-off may persist till there’s some assurance from the Fed.

“We don’t see the Fed withdrawing the QE programme soon as the US unemployment rate is over 7.5%, higher than what the Fed would like to see. Also, they would like to see sustained recovery before taking that call,” said Rajesh.