India’s financial markets are facing renewed pressure as recent foreign exchange restrictions imposed by the Reserve Bank of India (RBI) have made it more expensive for overseas investors to hedge rupee risk. The development has significantly affected the India bond market outlook, while growing geopolitical tensions and rising oil prices continue to weigh on equities.
Foreign investors, already cautious amid global uncertainty, are now reassessing their exposure to Indian government bonds and stocks.
RBI Measures Push Up Hedging Costs
The RBI recently introduced steps aimed at stabilizing the rupee and reducing speculative arbitrage trades. While these measures have helped limit currency volatility, they have also sharply increased hedging costs for foreign investors.
In the onshore over-the-counter market, one-year hedging costs have risen by nearly 30 basis points, while offshore non-deliverable forward (NDF) hedging costs have surged by almost 70 basis points. In fact, NDF costs touched their highest level in over 12 years immediately after the RBI’s move.
This has worsened the India bond market outlook, as higher costs erode the returns foreign investors typically expect from Indian debt instruments.
According to market participants, the increase in hedging expenses has nearly wiped out the carry and roll-down benefits offered by Indian government bonds.
Foreign Investors Pull Back from Bonds
The worsening India bond market prospects are evident in capital flows. On the one hand, this is the sale of Indian government debt by foreign investors since the beginning of the Iran war on February 28, totaling about 211 billion rupees (2.26 billion) in value.
Selling speed increased even further when the RBI declared its curbs on foreign exchange.
The offshore NDF market, which is a very important avenue of managing exposure to the rupee, has also become very thin. This implies that it is not only more costly to hedge but also more difficult to do effectively.
To international fund managers, this renders this equation less appealing in terms of risk and reward.
Oil Prices Add Fresh Pressure
The next major aspect that is damaging the India bond market outlook is the sudden increase in the cost of crude oil owing to the increasing tension in the Middle East.
India is almost a 90 percent importer of its oil needs, with a large part of this being imported in the region. With oil prices increasing, the issues of inflation, current account deficits, and fiscal strains grow.
Recent reports show that oil prices have shot up by more than 40 percent since the war started, and this has created new downward pressure on the rupee and the general investor sentiment.
Even in the case of a stabilization of currency volatility, higher oil prices might postpone any significant recovery in foreign inflows.
Equities Also Face Earnings Risks
The impact is not limited to bonds. The slowing growth in earnings is also a pressure on Indian equities.
Increased cost of energy and uncertainty in the world have been seen to reduce the earnings expectation of various industries through the brokerages. This has provided an extra dimension of concern to the Indian bond market perspective since foreign investors tend to evaluate both debt and equity risks.
The poor earnings momentum, coupled with the currency instability, will probably continue to leave foreign investors on the fringes in the short term.
What Lies Ahead?
The short-term India bond market outlook is optimistic. Analysts feel that it might take a significant increase in bond yields before foreign sentiment can be improved.
Even though the RBI has done its best to stabilize the rupee, the increased cost of hedging and the prevailing geopolitical risks still affect investor confidence.
The inflows into Indian bonds by foreigners might be subdued in the next few months unless the oil prices are relieved and currency stability is restored
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