Hot-money risks seen rising as India courts ‘bond tourists’

A series of measures from the central bank to lure foreign buyers into the country’s short-term debt market could easily backfire, investors fear, exposing the economy to volatile “hot money” flows.

The Reserve Bank of India lifted (RBI) a restriction limiting foreign investors to buying bonds with three years or more to maturity and also gave them access to short-term sovereign treasury bills.

Rapid fire switching

The RBI’s lifting of the maturity restriction came after government bonds tanked when sovereign bond auctions failed to attract many buyers, followed by a spike in yields when surprisingly hawkish minutes of a monetary policy meeting raised fears of the RBI hiking interest rates.

The new rules have stoked fears of an influx of “bond tourists” and the associated rapid-fire switching in and out of short-term debt by foreign traders.

Such volatile flows could make India’s financial markets more vulnerable at a time when the rupee has been the worst performer in the region, high oil prices are driving up the current account deficit, and interest rates could soon rise on heightened inflation risks, investors said.

“It encourages more short term inflows and therefore exposes India to more hot money flows and volatility in the long run,” said Johnny Chen, an investment manager at NN Investment Partners in Singapore, focusing on Asian local currency debt.

The RBI did not have an immediate response when asked to comment on the traders’ remarks.

The immediate reaction to the lifting of maturity curbs on overseas buyers was less than inspirational, with foreigners selling a net $240.92 million of bonds on May 2 - a day after the RBI’s announcement.