FPIs Record Highest Government Bond Sales This Quarter Since Global Index Inclusion

Foreign Portfolio Investors (FPIs) have registered their largest-ever quarterly outflow from Indian government securities since the country’s bonds were included in major global bond indexes, driven by a narrowing interest rate differential between Indian and U.S. 10-year government bonds. Experts attribute this outflow to the shrinking yield gap, currently around 180 basis points (bps), following the Reserve Bank of India’s (RBI) recent rate cut cycle, which has reduced the attractiveness of Indian debt relative to safer U.S. assets.

Highlights:

• FPIs pulled out Rs 25,543.68 crore from Indian government bonds between April 2 and June 3

• This is the first quarterly outflow since inclusion of Indian bonds in global indexes in 2023

• Interest rate differential between India and U.S. 10-year bonds narrowed to about 180 bps

Historical Inflows Since Inclusion in Global Bond Indexes

Indian government securities have experienced significant inflows from foreign investors ever since their inclusion in major global bond indices, which began with JPMorgan Chase & Co’s announcement on September 22, 2023. Subsequently, Bloomberg and FTSE Russell followed suit by adding Indian government bonds to their emerging markets bond indexes. This inclusion provided Indian government securities with greater visibility and accessibility in international markets, prompting steady quarterly inflows as FPIs sought exposure to India’s relatively higher yields.

Highlights:

• JPMorgan first included Indian bonds in its Government Bond Index – Emerging Markets (GBI-EM) in September 2023

• Bloomberg and FTSE Russell followed with inclusion in their emerging market bond indexes

• Every quarter post-inclusion had seen positive FPI inflows into Indian government bonds until the current quarter

The Role of the Fully Accessible Route (FAR) in FPI Participation

The recent outflows have been tracked under the Fully Accessible Route (FAR), which permits non-resident investors to directly invest in specified Government of India dated securities without any upper investment limits. FAR was introduced to liberalize access to Indian bonds and encourage foreign investment. While the mechanism enabled robust inflows initially, the recent decline in yield attractiveness has reversed this trend, causing foreign investors to withdraw substantial sums.

Highlights:

• FAR allows unrestricted foreign investment in specified Indian government bonds

• Enabled significant inflows post-global index inclusions

• Current quarter marks the first major reversal with significant outflows

Interest Rate Differential Shrinks Impacting Foreign Investments

The core factor behind the FPI sell-off is the shrinking interest rate differential between Indian and U.S. 10-year government bonds. Early in 2025, the RBI commenced a series of rate cuts aimed at stimulating the economy. While these moves reduced borrowing costs domestically, they also compressed the yield spread between Indian bonds and their U.S. counterparts. Foreign investors generally prefer higher yields in emerging markets to compensate for currency risk and other compliance costs. As this premium diminishes, the incentive to hold Indian debt weakens, prompting capital flight back to lower-risk U.S. markets.

Highlights:

• RBI rate cuts narrowed India-US 10-year bond yield spread to approximately 180 bps

• Narrower spreads reduce foreign investor returns after currency and compliance adjustments

• Investors tend to move funds to safer assets when yield differentials compress

Potential for Continued Outflows amid Expectations of Further Rate Cuts

Market analysts caution that the outflows may persist or even intensify, as expectations build for additional RBI rate cuts. Further monetary easing could drive Indian bond yields even lower, reducing the yield advantage over U.S. Treasuries. This dynamic may weaken foreign appetite for Indian government securities unless offset by positive economic reforms or currency stabilization. The trend highlights the sensitivity of FPI flows to monetary policy divergence between emerging markets and developed economies.

Highlights:

• Anticipation of more RBI rate cuts may cause further reduction in Indian bond yields

• Additional narrowing of yield spreads could prompt more FPI outflows

• Sustained foreign selling may pressure Indian bond markets unless other factors intervene

Implications for India’s Debt Market and Currency Stability

The record outflow of foreign funds from government securities poses challenges for India’s debt market stability and could exert downward pressure on the Indian rupee. Foreign investors play a crucial role in financing government borrowing at competitive rates, and their withdrawal may lead to higher yields and borrowing costs domestically. Moreover, capital outflows could trigger rupee depreciation, complicating inflation management for the RBI. Policymakers will need to monitor the evolving global interest rate environment and investor sentiment closely to mitigate volatility.

Highlights:

• FPI sell-off may increase bond yields, raising government borrowing costs

• Capital outflows risk rupee depreciation and inflationary pressures

• RBI faces balancing act between supporting growth and maintaining market stability

Global Index Inclusion’s Long-Term Significance Despite Near-Term Outflows

Despite the current quarter’s outflows, experts maintain that the inclusion of Indian bonds in global indexes marks a historic step in integrating India’s debt market with the global financial system. Over the long term, such inclusion is expected to enhance liquidity, deepen the bond market, and attract stable, quality foreign capital. The recent outflows are viewed as a cyclical response to shifting interest rate dynamics rather than a structural retreat. Market watchers emphasize the importance of ongoing reforms and macroeconomic stability to sustain foreign investor confidence.

Highlights:

• Global index inclusion boosts India’s bond market visibility and liquidity

• Current outflows reflect short-term yield and policy shifts, not structural withdrawal

• Continued reforms critical to maintaining and growing foreign investment flows