FAR bonds lose their pull as tailwinds fade

Mumbai: After a surge in June, foreign inflows into government securities under the Fully Accessible Route (FAR) have started to moderate, as the factors that initially drove strong investor interest begin to fade. The June rally in FAR bonds was fuelled by expectations of India's inclusion in global bond indices, attractive carry offered by government securities, and policy support from the regulatory and the political establishment.

However, the recent slowdown reflects narrowing India-U.S. yield spreads, renewed concerns over rupee weakness and disappointment over the Bloomberg index rejig.

Since June 5, when the Reserve Bank of India (RBI) and the government announced measures to attract foreign capital, ₹53,289 crore has come into government securities through the FAR route.

However, the pace of inflows has eased from the levels seen immediately after the announcements. The largest single-day inflow was recorded on June 14 at ₹14,034 crore, while average daily inflows over the past week have moderated to around ₹500 crore, CCIL data showed.

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The moderation is driven largely by a less favourable yield differential between Indian and U.S. government bonds. While Indian debt continues to offer relatively high yields, the premium over US Treasuries has narrowed significantly, reducing the attractiveness of rupee-denominated assets for global investors.

"Yes, Indian bonds are high yielding, but we have to remember that the world's biggest bond market is also high yielding. The difference between India and U.S. rates has narrowed to 2-2.5% from 4-4.5%, so the U.S. is very attractive, and we think investors would prefer the dollar market," said Daryl Ho, senior investment strategist at DBS Bank.

Additionally, many foreign investors had expected Bloomberg to announce a decision on the inclusion of Indian government bonds in its Global Aggregate Index by mid-July. The delay in the announcement has prompted some foreign portfolio investors to pare their holdings, adding to the moderation in inflows.

Another key concern is the rupee's recent depreciation.

The currency was trading in the 94.50-94.60 per dollar range in mid-June but has since weakened amid rising crude oil prices and escalating geopolitical tensions. The rupee closed at 96.56 per dollar on Wednesday, raising concerns that currency losses could erode returns on rupee-denominated bonds.