Banks Are Grabbing All the Indian Bonds Foreigners Dump

Domestic investors, led by lenders, are piling into Indian bonds on optimism the central bank stands ready to soak up a record debt supply. That‘s pitting them against foreigners who continue to sell the nation’s debt.

Banks raised their holdings of sovereign notes to 41.4 trillion rupees ($555 billion) on bets the Reserve Bank of India will take measures to support the bond market, given the governments 12-trillion rupee issuance plan.

Surplus cash in the banking system has put lenders in the driver‘s seat at a time when global funds have been net sellers for four straight months because of a weak currency and high hedging costs. With India’s budget deficit set to widen, a steady source of support for bonds is crucial for the success of the administrations record borrowing plan.

“There‘s liquidity overhang because deposit rates have remained largely stable and there’s no credit demand,” said Anoop Verma, senior vice president at DCB Bank in Mumbai. For foreigners, the rupees 4.8% slide in 2020 has reduced the “carry trade” appeal of Indian debt, he said.

The returns for foreigners after adding hedging costs are slim, even before considering funding expenses. For example, onshore hedging cost, as measured by the rupees one-year forward-implied yields is at 3.7%, while the one-year government bond yields 3.67%.

For local lenders awash in excess liquidity of about 6.6 trillion rupees and poor demand for loans, sovereign bonds are the best bet. Especially after the central banks aggressive rate cuts this year to support the coronavirus-hit economy.

More Incentive

It‘s little wonder that they’ve raised their holdings of government debt by 13% from March 31 through June 19, the latest RBI data show. The purchases helped push down the yield on the most-traded 2029 notes by 15 basis points in the second quarter.

But with banks brimming with government paper, the RBI must provide them an incentive to add more, traders say. One way is to allow lenders to keep a bigger slice of their debt holdings in the so-called held-to-maturity category, which shields them from price swings.

Under current rules, banks can hold 25% of their investments in the HTM bucket, with up to 19.5% being sovereign notes. A one percentage point rise can boost banks appetite by 1.4 trillion rupees, according to ICICI Securities Primary Dealership Ltd.

“Central banks globally are doing everything to bring down rates to support growth and the RBI should also ease the HTM rules to enable banks to keep buying bonds,” said Sajal Gupta, head of FX and rates at Edelweiss Securities Pvt. in Mumbai.