Foreign flows into Indian bonds may remain muted despite tax relief: SBI Funds

Foreign investment flows into Indian government bonds are expected to remain limited in the near future, despite tax relief on overseas purchases, as global yields, domestic interest rate cycles, and rupee expectations impact investor interest, according to SBI Funds Management. The report predicts that the delay in India's inclusion in a global bond index could further limit foreign portfolio investment (FPI) in Indian bonds.

Even with tax relief, the relative yield differential, current policy cycle, and expectations around the INR do not provide strong incentives for increased foreign demand for Indian sovereign bonds, the analysis states. Any flows that do occur are anticipated to be strategic and driven by currency expectations. SBI Funds also predicts the Reserve Bank of India (RBI) will likely maintain an extended pause on interest rates, with any normalization of policy rates likely to be further delayed.

The RBI's recent policy guidance, which references core inflation near its 4 percent target, suggests a continued willingness to tolerate headline inflation above the 4 percent target. Global interest rates remain a significant challenge for foreign flows into Indian bonds, as weaker fiscal conditions and inflation exceeding target in several developed economies keep global bond yields high.

The report notes that domestic interest rates are expected to receive little support from external flows in the near term.