Index entry wait may temper bond rally as FPI inflows start to ease

The rally in Indian bonds could slow as flows from foreign portfolio investors (FPI) begin to ebb amid no definitive signs of Bloomberg's Global Aggregate Index including local sovereign debt in its latest rejig, while the yield differential with developed markets continues to narrow.

Contrary to the June quarter, the benchmark government bond may trade in a tight range as multiple factors - from higher government borrowing to an uncertain outlook on the interest rate trajectory - limit investor enthusiasm, said bond traders.

The yield on the benchmark 10-year government bond fell more than 30 basis points in the first quarter of FY27. A basis point is 0.01 percentage point. But traders do not expect a similar rally.


"The market was running on expectations that India will be included in the Bloomberg index shortly. If this doesn't happen, we could witness a sell-off of 8-10 bps while an early announcement of a positive development on this front can make the yields soften by 3-4 bps," said Vijay Sharma, senior executive vice-president, PNB Gilts.

One basis point is a hundredth of a percentage point.

"Nonetheless the new joker in the pack is again crude and it will remain one of the main factors which will dictate the final yield movement in either of the above cases," Sharma said.

Yields on the 10-year benchmark bond closed at 6.84% on Thursday.

At current levels, inclusion in Bloomberg's Global Aggregate Index is priced into yields. If included, the upward bias may turn into an easing bias if crude oil prices remain around $70-80 per barrel, traders said.

Pressure on Yields

However, if India is not included, the negative bias is expected to accelerate.

"We expect some sobering effect on bond yields although there will be no sharp movement," Axis Bank's chief financial officer, Puneet Sharma, said during the post- earnings media call.

Bond yields softened about 30 basis points in the June quarter tracking the oil price movement, Sharma said.

The altered outlook on yields could change many equations for both borrowers and banks, which rely on the fixed income market for a substantial portion of their revenues, including trading and arranging sale of bonds.

Gopal Tripathi, head of treasury, Jana Small Finance Bank, agreed. "Yields will move in a narrow range, but the bias would be upward. It will be difficult for yields to move below 6.60% levels, even if Indian bonds are included in the Bloomberg Index. Hence, treasury gains are expected to be under pressure," Tripathi said.