Foreign investors continue to profit from owning Indian debt as long as the country's development engine remains robust and inflation behaves. In summary, India's yield advantage won't be eliminated anytime soon by the Fed.
A particular area of the Indian economy—bonds—may benefit from certain changes in the US economy. With the exception of sporadic short-term fluctuations, capital flows from the US into India are not only likely but also anticipated to continue steady given the economic patterns in the largest economy in the world.
Additionally, Indian investors can profit from seemingly unconnected economic moves in the United States.
In its most recent policy, the US Federal Reserve lowered interest rates for the third consecutive year. Weaker labor market conditions served as the primary justification for the policy's balance. With only one rate decrease factored in by the Fed, the Bank of Baroda (BoB) claims that there is little room for additional easing in CY26.
What does this policy entail for India, then?
At a time when the volatility of the rupee has increased, it becomes critical from the perspective of the interest rate difference between India and the US. Due to the RBI's faster rate decreases than the US, the policy rate gap between India and the US has been largely managed. The yield differential has also mirrored the same trend, thus supporting FPI flows in the initial months. However, the recent volatility of the rupee has had an impact on flows of late.
When making a choice, "FPI flows would continuously evaluate the interest rate differential along with the rupee movement," according to BoB Chief Economist Madan Sabnavis. A trade agreement (between the US and India) may be advantageous for these institutions, but rupee volatility is detrimental (the cost of operations may rise).
It's obvious that the US Fed is easing, but it's not happening quickly or forcefully. Instead of thinking of it as a stimulation bazooka, consider it slow respite. Although rates are declining, they will remain comparatively high for a while longer, according to Nikunj Saraf, CEO of Choice Wealth.
This is actually a comfortable zone for India.
Foreign investors continue to profit from owning Indian debt as long as the country's development engine remains robust and inflation behaves. In summary, India's yield advantage won't be eliminated anytime soon by the Fed.The interest rate disparity is anticipated to remain favorable as US Treasury yields stabilize and Indian bond yields continue to be relatively high.
Changes in the structure of FPI inflows
Additionally, compared to earlier flows, the present inflows into Indian bonds exhibit notable structural changes. According to Saraf, "this cycle is different from previous ones because FPIs are no longer coming only for short-term carry trades."
The game has altered as a result of India's inclusion in international bond indices, since passive index-linked flows persist even in times of short-term volatility. Not every global wobble is responded to by these flows.
Currency fluctuations may make monthly figures appear erratic, but the medium-term trend is favorable. According to analysts, India continues to be a reliable addition to international bond portfolios as long as the rupee doesn't appear shaky and yields don't plummet.
Sabnavis points out that more inflows into India's debt market would result from a further rate decrease in the US and a decline in bond yields there.
Reduced US yields push investors toward emerging markets by lowering the global "risk-free" return. Only when rate cuts indicate panic, such as during a recession or financial hardship, do flows abruptly reverse. That's not the background right now.
In fact, India will benefit if more cutbacks cause the dollar to decline. For foreign investors in Indian bonds, a weaker dollar increases overall profits and relieves pressure on the rupee.
Which bonds might draw inflows from FPI?
Unlike stocks, Sabnavis points out that FPI flows into Indian bonds are driven by the bond's credit rating and liquidity rather than being sector-specific.
Yields are gradually reduced by steady foreign investment, especially in government securities where index buying is concentrated. This lowers risk premiums, facilitates trade, and increases liquidity, all of which help corporations borrow money more affordably. But rather than being a one-day rally, it's a gradual structural change.
According to Saini, there are three types of investments (in the world of bonds): government securities, corporate bonds, and SDLs (state development loans). According to him, G-Secs are more appealing than SDLs because of their liquidity and reduced credit risk, which makes them more comfortable for international investors.
Increased corporate borrowing can make corporate bonds more appealing by increasing yield without taking on too much credit risk.
According to Saini, "sustained FPI inflows into the Indian bond market would have a softening impact on yields." Demand for government securities and high-yield bonds increases as foreign investors expand or diversify their holdings, which raises bond prices and, as a result, lowers yields. However, other factors including government borrowing, inflation trajectory, and RBI liquidity policy also have an impact on this effect.
The retail investor might also benefit from FPI flows into Indian bonds.
According to Saraf, retail investors don't have to keep up with every Fed meeting or FPI flow chart. Staying in line with the structural direction of the big money is the wiser course of action. Stable yields and progressive compression are advantageous for target-maturity and roll-down funds that concentrate on government securities. If foreign demand causes the mid-curve to richen, gilt and constant-maturity funds benefit, he explains.
He adds that the concept is straightforward: ride the structure, not the noise, and that high-quality corporate bond funds stand to gain as spreads compress in a more liquid market.
Dangers
"One fewer Fed cut is not the biggest risk. Resurgent US inflation, a drastically stronger dollar, or an abrupt increase in risk aversion are all examples of global shocks, according to Saraf. Fiscal restraint and inflation management are significantly more important domestically than changes to foreign policy. Any decline there would be more detrimental to sentiment than a shift in the Fed dot-plot.
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