Government bonds and the rupee strengthened sharply on Tuesday as optimism over the prospect of Indian sovereign debt being included in a global bond index spurred hefty overseas investment in domestic assets, dealers said.
The rise in bond prices came despite an increase in India’s consumer price index inflation, which strengthens the case for the Reserve Bank of India to continue tightening monetary policy.
A sharp decline in the dollar index in anticipation of falling US inflation also bolstered the domestic currency, which racked up its largest single-day gain since July 27.
Yield on the 10-year benchmark bond settled at 7.08 per cent as against 7.14 per cent at previous close. Bond prices and yields move inversely. A fall of 1 basis point in the yield on the 10-year paper corresponds to a rise in price of roughly 7 paise.
The rupee closed at 79.15 per US dollar as against 79.53 per dollar at previous close. So far in 2022, the domestic currency has weakened 6.07 per cent against the US dollar.
Speculation of Indian sovereign debt being included in a global bond index has been growing since mid-August as several global financial firms such as Goldman Sachs have expressed favourable views on the process.
Inclusion in a global bond index is estimated to attract around $30 billion worth of flows in a year, significantly improving demand-supply dynamics for bonds and helping the government finance its fiscal deficit.
If the process is to be operational by mid-2023, an announcement would likely be made in coming days, dealers said.
“The announcement is expected around September 15-25 and that is why there is a degree of front-running by some FPIs (foreign portfolio investors),” a senior bond trader said.
“There were FPI flows worth close to Rs 1,000 crore today in bonds. The momentum is good and no one wants to miss out on such a sustained rally. That’s why there was no negative response to the inflation data,” he said.
Data released after trading hours on Monday showed that CPI inflation hardened to 7 per cent in August from 6.71 per cent in July, thus, staying above the upper tolerance limit of the central bank for the first eight months of 2022. The RBI’s inflation target is 4 per cent with a flexibility of 2 per cent on either side.
The RBI, which has raised the repo rate by a total of 140 bps since May, is expected to hike the benchmark policy rate by 35-50 bps again at its meeting later this month.
The rupee, which has outperformed most of its emerging market peers due to the RBI’s firm defence of the local currency, reaped the benefits of the waning dollar strength.
“Indian rupee registered the biggest one-day gains after July 27 amid long unwinding in the dollar and risk-on sentiments. The dollar inflows from foreign institutions and corporates also supported the rupee,” Dilip Parmar, research analyst at HDFC Securities said.
“The dollar gauge fell a third consecutive day, the longest losing streak in a month, in the run-up to the CPI data. The market participants’ pricing in the US consumer price data due later Tuesday will show that inflation is near peaking, challenging the dollar-dominance narrative,” he said. At 3:30 pm IST, the dollar index was at 107.90 versus 108.33 at the previous close.
The US consumer price index increased 0.1 per cent to 8.3 per cent in August, largely due to recent declines in gasoline prices. Parmar sees the rupee in a band of 78.61-79.70 per dollar over the near term.