FII bond sales taper, but will they return?

While bond sales by foreign institutional investors (FIIs) may be coming to an end, the bad news is they are unlikely to take large bets on Indian debt anytime soon, aver experts.

Though the US Federal Reserve is unlikely to signal an abrupt end to its quantitative easing (QE) programme, investors are likely to be more discerning about investing money into countries like India.

The FIIs on Tuesday bought debt worth `221.90 crore in the secondary market even as they were net sellers by `583.90 crore on overall basis.

This buying comes after a 19-day selling streak that resulted in total debt outflows of nearly $4.7 billion.

Rob Subbaraman, chief economist and head of global markets research, Asia ex-Japan at Nomura Securities, believes the sell-off is a healthy short-term correction, and not the start of a bear market.

He believes once markets understand that the QE unwind will be done very gradually, capital inflows should return to Asia but he sees investors differentiating among countries within Asia.

“If investors become more discerning, the investor preference would be not simply for fast growth, but rather those countries with the strongest economic fundamentals. By contrast, countries where economic fundamentals are weak, structural reforms remain stymied or loose monetary policy is maintained despite financial excesses could struggle to attract investment. We would put China, Hong Kong, India and Indonesia in this category,” he said in a regional strategy report on Tuesday.

As per the Central Depository Services data, currently only 46.18% of the overall $81 billion debt limit available for FII investments remains utilised.

FIIs have been selling bonds because of the sharp currency depreciation along with narrowing yield differential, which has contracted by nearly 100 basis points since the start of May from 6.10% to 5.11% now. Taking into consideration the costs of borrowing and hedging, the current scenario offers no arbitrage opportunity for them.

Samiran Chakraborty, regional head of research at Standard Chartered Bank India, believes any rebound in flows will depend on what the US Fed statement is interpreted by the markets and how investors perceive the Indian currency.

“The US Fed is unlikely to specify the exact timeline of exit so any appetite for Indian bonds will depend on how the markets interpret the statement. If the Fed doesn’t do away with QE, we may see some of the outflows return as the yield behaviour (of the US 10-year bond) is likely to change. Those who believe that rupee may have seen the worst may not hedge and buy bonds to take advantage of probable rupee appreciation,” he said.

The appetite for Indian bonds is likely to be tested on Thursday as the regulator would be auctioning the unused free limit of `42,022 crore in government debt to FIIs registered with the Securities and Exchange Board of India under the categories such as sovereign wealth funds, foreign central banks and other long term investors.

Arjun Parthasarathy, editor of website investorsareidiots.com, believes there’s high probability of Fed providing a timeline for paring its bond purchase programme and that the debt auction on Thursday should do well.