Key facts
- Foreign investors are favoring short-term Indian government bonds.
- Bonds with maturities under five years comprised over two-thirds of foreign purchases between March and May.
- This represents an increase from January-February.
- The shift is attributed to attractive entry points and expectations of an interest rate cycle turn.
- Rising inflation, influenced by the Iran war, is a contributing factor.
- India has announced a tax exemption for foreign investors on government securities.
Foreign investors are increasingly opting for short-term Indian government bonds, finding attractive entry points amid expectations of an interest rate cycle turn, with the Iran war driving inflation higher. Bonds with maturities of less than five years made up over two-thirds of the top 10 notes foreign investors bought during March-May, a higher proportion than less than half in January-February. Overseas investors bought bonds worth 221 billion rupees in January-February, sold a record 177 billion rupees in March, before turning buyers in April-May. Indian government bond yields have risen over the last three months, with shorter duration yields spiking on inflation concerns due to the Iran war-linked energy shock. The 10-year benchmark bond yield rose 34 basis points from March to May, while the five-year yield rose 55 bps, with the spread dropping to an eight-month low of 15 bps. Investors are factoring in a shift toward tighter policy, with the Reserve Bank of India widely expected to hold rates at the June meeting, though the policy direction is shifting. In such an environment, the front end of the yield curve offers more attractive risk-adjusted carry with lower duration risk, while the long end remains vulnerable to further repricing if the tightening cycle materializes. The curve has bear flattened with short-end yields rising more than the long-end yields, creating a valuations-driven opportunity for foreign investors to buy short-end bonds. In a move to attract more stable foreign capital, India has announced a tax exemption for foreign institutional investors and the Bank for International Settlements, removing capital gains tax on interest and sales of government securities.