Foreign banks likely to extend bond buying spree in September

Foreign banks are expected to lap up Central government bonds this month on hopes of peaking policy rates and bets of an inclusion of local bonds in global indexes, extending a buying spree that started in July.

Overseas banks were the largest buyers of Central government bonds in August after returning to the market as net buyers in July. They were net sellers in the first six months of the year.

"Fundamentals are not very strong but the sole driver, for the time being, is speculation over index inclusion and this will continue to drive more purchases from foreign participants," said Ritesh Bhusari, deputy general manager, treasury, at South Indian Bank.

Bond bulls got a boost after the Financial Times reported in August that JPMorgan was speaking to large investors about adding India to its emerging markets bond index.

Goldman Sachs has said it expects an inclusion in 2023, estimating that an addition could trigger inflows of $30 billion.

Foreign banks bought bonds worth Rs 14,700 crore($1.84 billion) on a net basis in July, their highest since February 2020, and followed that with a purchase of Rs 11,800 crore in August.

The yield on the benchmark India 10-year bond eased 13 basis points in August, mirroring a similar move in July, following the inflows.

"Positive news towards index inclusion along with a view that bulk of the rate hikes are behind us is propelling these purchases, which seem to be sustainable for the time being," said Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership.

The Reserve Bank of India has already hiked its key policy rate by 140 basis points in the three months August. Market participants expect it to raise rates by another 60-85 basis points by the end of this financial year depending on the inflation trajectory.

Foreign Portfolio Investors

Alongside overseas banks, foreign portfolio investors also stepped up bond purchases, spending a net Rs 4,100 crore in their biggest purchase since January.

The bulk of those purchases has been in bonds under the so-called "Fully Accessible Route" category, which allows unlimited foreign investment in select liquid securities.

Foreign investors are exiting other bonds and re-investing those funds in liquid notes that fall under FAR, a trader with a primary dealership said.

"Even as the interest rate differential between U.S. and Indian bond yield has dropped to 400 basis points, foreign players are still keen to go for local notes, but if we do not hear any progress on the index inclusion front by month-end, we may see some reversal," South Indian Bank's Bhusari added.