FPI investments in Indian G-secs could revive as Fed’s monetary tightening nears its end

Foreign portfolio investors’ (FPIs) exposure to the Government securities (G-Secs) has hit a decadal low. But this could improve going forward as uncertainties regarding growth reduce and the US Fed’s monetary tightening draws to an end.

According to the latest data, foreign investors used only 18.30 per cent of their total investment limit in G-Secs (both under general and long-term categories) at the end of March 2023, the lowest since 2014.  The utilisation rate fell further to 17.62 per cent at the end of the June quarter. In absolute terms, FPI investment in G-Secs stood at ₹71,335 crore as of June 2023, against the available limit of ₹4.05-lakh crore. To give a perspective, FPI utilisation in G-Secs stood at 91 per cent of the eligible limit at the end of March 2018.

Consequently, their ownership in the dated securities also fell. Per the latest ownership data, FPIs held only 1.4 per cent of the outstanding dated securities at the end of March 2023, against 4.4 per cent at the end of March 2018.

Frequent hikes by Fed

Experts say the frequent interest rate hikes by the US Fed Reserve have reduced the spread between US Treasury yields and returns on Indian debt instruments.

“Although domestic rate hikes have taken a pause, western countries continue to implement further rate hikes, resulting in an all-time low spread in central bank rates,” said Vivek Goel, Joint Managing Director, Tailwind Financial Services.

After ten consecutive rate hikes and a pause in June, the US Federal Reserve today hiked rates again by 25 bps to tame the inflation.  The Fed Funds rate is now at 5.25–5.50 per cent — its highest level in the last 22 years.

In a rising interest rate environment, FPIs prefer to invest in their home market in US dollar assets, which is considered a safe bet at times of macro uncertainties.

This could, however, change going forward as the rate hike cycle of the US Fed draws to an end. The US dollar has fallen from its peak last September, and money could begin to flow into emerging market debt again.

This is already evident in FPIs turning net buyers of Indian debt since the beginning of the current fiscal. After pulling out ₹8,937 crore in FY23, FPIs have pumped in ₹16,320 crore in Indian debt so far this year. On a calendar year basis, FPI inflows into debt year-to-date stands at ₹19,782 crore.

Commenting on the latest Federal Open Market Committee (FOMC) outcome, Emkay Global said the end of the rate hike is near. “We maintain that the economic lags of massive hikes will not necessarily require further Fed hikes beyond July,” said Madhavi Arora, Lead Economist at Emkay Global Financial Services.

Corporate debt

In corporate debt too, FPIs have invested ₹1.04-lakh crore as of March 2023, utilising only 15.52 per cent of their total eligible limit of ₹6.68-lakh crore. The utilisation marginally went up to 15.67 per cent at the end of the June quarter. To give a perspective, FPI utilisation in corporate bonds stood at 91.85 per cent of the eligible investment limit of ₹2.44-lakh crore as of March 2018. However, while the investment limit has since increased to over ₹6.5-lakh crore, the actual investments have been dwindling year after year.

The sharp drop in FPIs investment in corporate bonds came after the IL&FS scam in 2018, which was followed by a series of defaults in the non-banking finance company (NBFC) space.

The outflow from Indian bonds has been further exacerbated since the Covid-19 pandemic.

On the other hand, FPIs have been pouring record amounts of investments into Indian equities. Between FY20 and FY23, FPIs invested ₹1.02-lakh crore in Indian equities while pulling out ₹1.06-lakh crore from Indian debts.

“The flow of investments between equity and debt markets hinges on various factors, including the perceived return differential and exchange rate stability,” Goel said.

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