Market watch: FPIs turn net debt sellers in 2018

Halfway through March, foreign portfolio investors (FPIs) have become net sellers of debt to the tune of $1.45 billion. Of the nine trading days until March 14, FPIs were net buyers of debt on just one day, March 6: $38.24 million. While on the other eight days, they were net sellers for a total of $1.49 billion worth of debt.

There is reason to worry about lower FPI investment in debt, as 2017 saw them as net buyers of debt worth $23 billion - nearly 3 times higher than their net buying of $7.8 billion in equity in 2017. The year-to-date performance is further lackluster when compared to the similar period over the last five years. FPIs were net buyers for $6.2 billion each in 2014 and 2015, and $ 1.3 billion in 2017, while, in 2016 they were net sellers of debt worth $1.2 billion.

It was rising interest rates and worries of fresh government borrowings in April that made FPIs sell. The volatility in the exchange rate is also adding to the challenges. A look at the 10-year government securities' interest rates shows the gradual increase in the rates in the recent weeks.

"The situation of rising yield has also been aggravated with the bond yields going through the roof," says Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India. Ghosh highlights that bond yield in India have jumped by close to 3 times than what it rose in the US (for the 8 month period ended March) implying that the increase in bond yields in India is not just from the tightening of global yields. "One such factor could be the asymmetric liquidity management by Reserve Bank of India," says Ghosh. "Alternatively, it is withdrawal of permanent liquidity through Open Market Operations but injection of temporary liquidity through repo," he adds.

Additionally, public sector banks, who are the largest players in the government securities market, have been reducing their buys owing to huge mark-to-market losses in their treasury books. Rating agency India Ratings and Research, in a February 13 note, had said that large losses emanating out of the quick rise in bond yields will result in large mark-to-market losses on banks’ non held-to-maturity investment holdings.

Ghosh argues that the theory of bond yield being affected by banks' offloading of government securities is not valid. Excess Statutory Liquidity Ratio (SLR -- specified portion of bank deposits which is to be held in cash, gold, or specified investments including government securities),  that increased to double digits for a few months after demonetization has declined steadily and reached to about 9% in the recent month, according to Ghosh.

From a high of excess SLR worth Rs. 12.73 lakh crore for the fortnight ended January 6, 2017 the excess SLR has fallen by Rs. 1.84 lakh crore to Rs. 10.89 lakh crore, for the fortnight ended February 16, 2018. In the last three months the excess SLR holdings of banks fell by Rs. 21,389 crore. "Offloading of Government securities by banks is not the primary reason for bond yields rising as this number has not been significant," Ghosh says.

Rising rates and falling yields could be a good opportunity for FPIs to return to be net buyers in debt, from net sellers.