Investors dump Indian bonds on concerns over banking regulations, weakening rupee

Global funds are dumping Indian bonds at the fastest pace since December 2016 as a bank fraud and a weakening rupee sap confidence in Asia’s highest-yielding major debt market.

Foreign holdings of government and corporate notes are set to drop for a fifth week, having fallen 146.6 billion rupees ($2.3 billion) since February 9. It was around this time last month that India unearthed a $2bn fraud at Punjab National Bank, which saw some jewelers allegedly colluding with PNB officials to obtain loans from overseas branches of other Indian lenders. The rupee is the region’s worst-performing currency this year after the Philippine peso.

“Portfolio flows have previously helped offset deteriorating fundamentals but the sentiment has weakened, with flows turning negative,” said Neeraj Seth, head of Asian credit at BlackRock, the world’s largest asset manager. “The weakness in the rupee means currency gains no longer offset losses from bonds and can trigger further selling.”

The selling by overseas funds threatens to exacerbate a sovereign-bond rout that’s inflicted losses worth billions of rupees on state-run banks -- the biggest holders of the securities -- prompting them to stay away from the market. The seven-month carnage has also spurred calls for intervention by the Reserve Bank of India.

As the market reeled from an excessive supply of government debt, rising global yields and worries that faster inflation could prompt the central bank to start raising interest rates, the bank fraud has served as another reason for foreigners to flee Indian bonds.

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[ Rupee depreciation against the dollar keeps deficit running ]

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The yield on benchmark 10-year sovereign notes climbed 126 basis points in the last seven months, the longest stretch in at least two decades. While the yield has fallen this month, it could face upward pressure in the coming weeks as the central government starts its 6.06-trillion rupee borrowing program in April.

The rupee has weakened 1.6 per cent in 2018 amid concern over India’s deteriorating public finances and fears that US President Donald Trump’s tariff plans will trigger a global trade war.

BlackRock’s Seth said India’s government may allow foreigners greater access to local debt to ease the pain. Bonds rallied Thursday after a report said policy makers may raise the investment limits for global funds.

“Looking ahead, April is an important month as this is where issuance of government bonds will resume,” said Seth. “The factors that could provide support for the market are buying from the RBI to inject liquidity, increase in the foreign limits for government bonds and clearer communication from RBI and/or the government.”