FIIs have invested around USD 20 billion in INR Bonds in the April-December 2014 period. Last week, FIIs sold USD 0.18 billion of INR Bonds and bond markets became jittery and sold off bonds. Ten year benchmark government bond, the 8.40% 2024 bond saw yields rise 14bps week on week to close at levels of 7.96%, after touching year lows of 7.78% in the beginning of the week. Three year benchmark AAA corporate bond yields rose 17bps week on week to close at levels of 8.67%.
FIIs have taken up their debt utilization limits to 73% of total limits of USD 81 billion from levels of around 35% seen in April 2014. FIIs have exhausted government bond limits of USD 30 billion and are incrementally investing in corporate bonds. Read our weekly money market analysis for FII activity in INR bonds.
Risk aversion rose last week on the back of the collapse of the Ruble after the Russian Central Bank hiked rates by 6.5% to 17%. Oil prices dropped to levels last seen in 2009 and have contributed to the 50% fall in the Ruble against the USD. The INR fell by around 2% to close at over one year low levels of Rs 63.30 to the USD on the back of global risk aversion.
FIIs were marginal sellers of INR Bonds given the INR fall as investments of USD 20 billion in this fiscal year were at levels of Rs 60 to Rs 62 against the USD. The question is will FIIs continue to sell INR bonds on worries of the INR weakening further?
FIIs are unlikely to sell INR bonds on worries of INR weakening further. on the fall in the Ruble and its knock on effect on the INR. Bond market nervousness stems from the heavy selling in INR bonds by FIIs last year when the INR fell to record lows against the USD in August 2013. Macro conditions were much weaker last year as compared to the current fiscal year and hence this time around FIIs will not be selling bonds in a hurry. Moreover, entering 2015, India is likely to see higher allocation from FIIs as they shift out of commodity driven economies to more stable economies such as India.
Bond yields will start trending down once market perceives that FIIs will stay invested in INR bonds.
OIS (Overnight Index Swaps) market saw the curve rising week on week with one year OIS yields rising by 15bps and five year OIS yields rising by 24bps to close at levels of 7.90% and 7.36% respectively. OIS yields rose on the back of INR fall and yields are likely to fall as the INR stabilizes.
System liquidity tightened last week on advance tax outflows of around Rs 600 billion. System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) was in deficit of Rs 1260 billion from Rs 646 billion seen in the week previous to last. Liquidity is likely to ease on government spending.