The surge in foreign portfolio inflows into debt instruments, following the inclusion of Indian government securities (G-Secs) in global bond indices, is beginning to taper. While around $1.8 billion was received through the fully automatic route for buying G-Secs since the beginning of this January, the voluntary retention route and general route witnessed outflows of around $1 billion. These outflows are impacting bond yields, with the 10-year bond yield rising to a three-month high last week.
The RBI’s recent measures to increase retail participation in G-Secs and to provide more instruments for hedging risk in these securities appear to be aimed at countering the growing risk of large FPI outflows from this segment. The G-Secs market is dominated by a few large players such as banks, insurance companies, foreign portfolio investors and mutual funds. Attracting individual investors to the G-Secs market is one way to insulate it from upheavals in global financial markets. The central bank introduced the retail direct scheme in 2021, in which retail investors were allowed to trade in the secondary market for G-Secs as well as participate in primary issuances, through an account with a bank. But this has not elicited sufficient interest; holding of government securities by individuals and turnover in the retail direct platform has been negligible. Low awareness and lack of comfort with this channel could also be holding back investors.
The RBI is trying to address this by allowing retail investors to trade in the G-Secs market through their stockbrokers. The electronic trading platform for government securities — the Negotiated Dealing System–Order Matching (NDS-OM) — is being made accessible to retail investors. Since they will be transacting through their stockbrokers, through whom they also buy or sell equities or commodities, more investors may come forward to trade on this platform. Increasing the number of participants can impart better depth and improve price discovery. Risk averse investors will benefit from investing in a long-term fixed income instrument which carries zero risk, given the sovereign guarantee these instruments bear. The proposal to introduce forward contracts on G-Secs also appears intended to attract more participants.
While large participants such as foreign portfolio investors or mutual funds can currently hedge their risk with interest rate futures, swaps and options, offering forwards on G-Secs will make hedging more efficient since each forward will be linked to a specific bond. With the Trump-driven turmoil unlikely to abate soon, foreign portfolio inflows can remain erratic in the months ahead. Rising US bond yields as well as the depreciation in the rupee add to the pressure on Indian sovereign bond prices. The RBI will have to do all it can to shield the bond market since the government’s fiscal balance and interest costs in the economy are dependent on it.
