Foreign investors pivot to short-term Indian debt ahead of policy shift
Data shows short-end instruments accounted for more than two-thirds of top purchases between March and May, reflecting a strategic move to capture risk-adjusted carry amid anticipated rate tightening.
Overseas investors have significantly increased their exposure to short-term Indian government bonds, with maturities of less than five years comprising over two-thirds of the top 10 notes purchased between March and May. This strategic pivot follows a period of volatility that included a record sale of 177 billion rupees in March, reversing the net purchases of 221 billion rupees recorded in January and February.
The shift in positioning coincides with rising yields across the Indian government bond market, driven by inflationary pressures linked to the conflict in Iran. Between March and May, the 10-year benchmark yield rose by 34 basis points, while the five-year yield surged by 55 basis points. Consequently, the spread between short and long-end yields narrowed to an eight-month low of 15 basis points, a technical formation known as bear flattening.
Krishna Bhimavarapu, APAC economist at State Street Investment Management, noted that investors are increasingly pricing in a shift toward tighter monetary policy. While the Reserve Bank of India is widely expected to hold rates at its upcoming June meeting, the broader policy direction suggests a move toward restraint. Bhimavarapu highlighted that the front end of the yield curve now offers more attractive risk-adjusted carry with lower duration risk, whereas the long end remains vulnerable to further repricing if the tightening cycle materialises.
Nagaraj Kulkarni, chief rates strategist at Standard Chartered Bank, described the bear flattening of the curve as a valuation-driven opportunity for foreign investors to acquire short-end bonds. Kulkarni pointed out that short-end yields, being most sensitive to interest rate changes, have spiked on energy shock concerns, creating entry points for overseas capital seeking to position ahead of a potential policy turn.
Market forecasts for the Reserve Bank of India’s decision, due on Friday, remain divided. While the consensus among economists points to a status quo, Standard Chartered Bank has called for a 25-basis-point hike. This divergence underscores the uncertainty surrounding the central bank’s response to inflationary headwinds, further incentivising foreign investors to favour the relative safety and yield of short-duration instruments.
