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Overseas investors are showing such keen interest in India assets that they are taking proxy exposure to the country even if they don’t have the license or physical presence to trade there.

Foreign funds lacking direct access to India’s $1 trillion government debt market are increasing their exposure via instruments such as supranational bonds and swaps ahead of the nation’s upcoming inclusion in global bond indexes.

There’s an “increased engagement from global investors, with momentum picking up this year,” said Siddharth Bachhawat, head for markets at Barclays Bank India. “In addition to interest from index-tracking managers ahead of the inclusion, discretionary activity from a wider investor base has also been notable.”

Indian sovereign bonds have gained prominence after JPMorgan Chase & Co.’s move to add them to its global debt indexes from June. Sovereign, supranational and agency entities are selling more debt denominated in rupees, with the size of such sales reaching a five-year high of $3.2 billion in 2023, widening the pool of securities available for foreign investors, data compiled by Bloomberg show.

“There’s been a marked increase in the sales of rupee-denominated SSA debt,” said Wontae Kim, research analyst at Western Asset Management. 

Investors such as William Blair Investments and M&G Investments are venturing into supranational bonds. Issued by multilateral agencies like the World Bank and denominated in Indian rupees, these triple-A rated notes give overseas investors exposure to local debt without having to secure a license to operate onshore.

“Given India’s disinflation trend and improved technical outlook with impending index inclusion, we favor duration in India,” said Johnny Chen, fund manager at William Blair in Singapore.

Also, buyers don’t have to pay 20% withholding tax as these securities are settled offshore, which results in higher yields, according to Claudia Calich, head of emerging-market debt at M&G Investments in London. 

“Even if the pretax yield on supranational bonds tends to be lower than on India government debt, the yield is higher on an after-tax basis,” she said.

Bonds Rally

The inclusion is widely expected to lure up to $40 billion of inflows. Global funds have begun to boost their holdings of index-eligible bonds since JPMorgan’s September announcement, adding over $8 billion of holdings. 

The purchases have helped make Indian bonds the second-best performers in local currency emerging market debt so far in 2024, according to Bloomberg data. Yields have fallen 12 basis points this year to 7.08%, a period in which Treasury yields have climbed 46 basis points.

Fund managers are also turning to derivatives such as total return swaps to tap local debt. The instrument gives overseas investors the same payoff they would get by owning local securities without having to open a domestic account or deal with local investing regulations.

“The activity in total return swaps will pick up meaningfully when you are sitting close to the cutoff date in June,” said Ashhish Vaidya, head of treasury at DBS Bank Ltd. in Mumbai. That’s because investors need time to secure approval for setting up operations onshore, he said.

--With assistance from Ayush Damani.

(Updates bond yields in 11th paragraph)

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