Inside India newsletter: India weighs a tax cut to win over foreign investors. Will it work?

Mumbai: The gap between India's 10-year government bond yield and the US 10-year Treasury yield has widened to over 240 basis points following a rate decision in Mumbai, but experts believe it should expand further to at least 300 basis points for Indian debt to appeal to foreign investors. A basis point is one-hundredth of a percentage point.

The spread was at 250 basis points last week, then slightly decreased. Foreign investor bond sales dropped by half in October, reaching around ₹5,615 crore. Fund managers say the current yield differential is comfortable but not sufficient to lure significant foreign debt. Gaurav Kapoor, chief economist at IndusInd Bank, notes that the spread is insufficient to attract substantial inflows on a fully hedged basis.

The US-India spread was around 180-190 basis points in September when US yields soared to decade highs, currently standing at 225 basis points. With the US yield at 4.93% and India's at 7.18%, market participants argue that the yield difference must be wider enough to cover hedging costs for overseas debt investors. Hedging costs have risen, but forward currency premiums are typically around 2.50%-2.75%, as they were in August-September.

Therefore, the yield difference should be higher than this to make Indian debt attractive for overseas buyers. Treasury heads emphasize that foreign investors' final returns also depend on the rupee and hedging costs. The Indian rupee rose about 1% against the dollar in October, its strongest monthly performance since February, aided by central bank measures to curb dollar demand and a weaker greenback, offsetting pressure from high oil prices and capital outflows.

However, outflows are not solely driven by yield differentials; currency stability also plays a crucial role, according to Alok Singh, head of treasury at CSB Bank.