The Reserve Bank of India's latest measures to ease foreign portfolio investment norms for government securities could mark a turning point for the country's debt markets, potentially attracting $50-100 billion in capital inflows over time, according to Vikas Garg, Head of Fixed Income at Invesco Mutual Fund.
In an exclusive interaction with ETMarkets Smart Talk, Garg says the RBI's decision to remove key investment restrictions for FPIs, expand the Fully Accessible Route (FAR) universe, and introduce complementary measures to boost foreign capital could deepen India's bond market and strengthen macroeconomic stability.
He believes these reforms, along with favourable tax changes and the prospect of India's inclusion in the Bloomberg Global Bond Index, could create sustained structural demand for government securities while providing long-term support to the rupee. Edited Excerpts -
Q) The RBI chose to keep the repo rate unchanged at 5.25% despite increasing global uncertainties. What factors do you think drove the MPC's decision to stay on hold and do you think it is the right one?
A) The macroeconomic backdrop has become increasingly challenging for the RBI since the April MPC policy. This has been driven by elevated crude oil prices due to the ongoing West Asia conflict, a shift toward hawkish monetary policy by global central banks to control inflation, a slowdown in economic growth, and significant depreciation pressures on the INR.
Unlike many other Asian central banks, the MPC has maintained a pragmatic approach—using policy rates primarily for inflation management, while relying on other tools to support the currency. India has entered this phase of global uncertainty with relatively stronger macroeconomic fundamentals compared to its peers.
The current inflationary pressures are largely supply-driven, stemming from factors such as higher commodity prices rather than demand-led overheating.
Although inflationary pressures are expected to remain elevated going forward, current inflation remains below 4%, which has provided the MPC with room to maintain the status quo on policy rates and await a fuller assessment of the impact of the West Asia conflict.
Q) The central bank retained its neutral stance even as inflation risks have risen. Does this indicate that the rate-cut cycle has effectively come to an end?
A) Yes, we believe the rate-cut cycle is over for now, even as the MPC has maintained policy flexibility with a “neutral” stance. This indicates that the MPC remains data-dependent, with the future policy direction to be guided by evolving growth–inflation dynamics.
While inflation has remained benign so far, the outlook is beginning to worsen, largely driven by higher energy prices. The second-round impact of rising input costs could exert additional upward pressure on inflation, making the near-term CPI trajectory more sensitive to these evolving cost dynamics.
In line with elevated crude prices, the RBI has revised its FY27 inflation projection upward by a sharp 50 bps to 5.1%, assuming an average crude oil price of USD 95 per barrel for FY27, compared to USD 85 assumed in the previous policy. Additionally, the overhang of a sub-normal monsoon could further elevate inflation expectations.
These factors, coupled with the fact that the current policy rate of 5.25% is close to the FY27 inflation projection of 5.1%, leave the real policy rate at a narrow margin, potentially warranting future rate hikes. That said, the timing and magnitude of any rate hikes will largely depend on the duration and intensity of the West Asia conflict.
Q) The policy statement repeatedly highlights elevated energy prices as a key risk. At what crude oil price does India's macroeconomic outlook become meaningfully vulnerable?
A) Domestic macroeconomic fundamentals are highly dependent on crude oil prices, as well as the stability of the Middle East, given India’s heavy reliance on the region to meet its energy requirements.
As a broad estimate, every USD 10 per barrel increase in crude prices can raise headline inflation by 40–45 bps, widen the current account deficit by a similar ~40 bps, reduce growth by 10–15 bps, and potentially expand the fiscal deficit.
A deterioration in macro fundamentals can also affect capital inflows, thereby putting pressure on the currency. In FY26, the Indian crude oil basket averaged around USD 70 per barrel, while April–May 2026 witnessed an average price of approximately USD 110 per barrel.
While short-term, episodic price shocks can be absorbed by India’s currently robust external position, any prolonged disruption and sustained elevation in energy prices could adversely impact macroeconomic fundamentals and trigger a downward spiral.
We believe that a stable crude oil price range of USD 80–90 per barrel is manageable for India without significantly disrupting its external stability.
Q) RBI has removed the short-term investment limit, security-wise limit, and concentration limit for FPIs investing in government securities under the General Route. How significant is this reform for attracting foreign capital into Indian debt markets?
A) The RBI has announced a series of measures to boost capital inflows, including an expanded FAR (Fully Accessible Route) security universe, a concessional hedged facility for ECBs, and fully hedged 3–5 year FCNR(B) deposits.
Separately, the government has relaxed taxation rules for FPIs investing in G-Secs, which could also increase the likelihood of India’s inclusion in the Bloomberg Global Bond Index.
By removing limits such as short-term investment caps, security-specific thresholds, and concentration restrictions, the RBI has simplified market access and reduced friction for foreign portfolio investors. This enhances flexibility and aligns participation in Indian government bonds more closely with global investment frameworks.
These measures could potentially trigger significant capital inflows, in the range of USD 50–100 billion over time, thereby strengthening domestic macroeconomic fundamentals.
Q) What impact could this move have on government bond yields, particularly in the longer end of the curve?
A) Quick capital inflows driven by measures related to ECBs, FCNR(B) deposits, and export proceeds will help arrest negative market sentiment and alleviate currency pressures. At the same time, these measures will boost INR liquidity, benefiting the overall debt market, including the G-Sec yield curve.
Additionally, tax benefits for G-Secs and the expanded FAR security universe could trigger direct inflows into the G-Sec market, particularly at the longer end of the yield curve, which has lagged in recent periods. In FY2026, the long end underperformed, as reflected in the widening of 10–30 year G-Sec spreads.
This was largely driven by a combination of higher issuance of long-duration bonds by the government and relatively muted demand from traditional investors such as pension funds due to shifts in their asset allocation.
However, the dynamics now appear to be turning favorable. The government has moderated the issuance of long-duration securities in 1HFY27, while pension funds are expected to re-enter the market more actively.
The RBI has also expanded the FAR security universe to include longer-tenor securities—such as 15, 30, and 40-year bonds. In this context, the potential entry of FPIs as an additional and sizeable investor base could further strengthen demand at the longer end.
This improvement in the demand–supply balance is likely to support bond prices and may lead to some degree of yield compression, particularly at the long end, resulting in a gradual flattening of the yield curve. Overall, these reforms enhance the structural demand outlook for longer-duration government bonds, which should be supportive for yields over time.
Q) Do you expect foreign investors to increase allocations to Indian debt immediately, or will global macro conditions remain the deciding factor?
A) We expect foreign investors to gradually increase their allocation to Indian debt, although the pace of inflows is unlikely to be immediate. India’s macroeconomic fundamentals remain relatively strong, characterized by political stability, a large debt market—the second largest among emerging economies after China—steady economic growth, credible fiscal discipline, moderate inflation, and relatively high market yields.
However, FPI participation in Indian G-Secs has remained limited so far, largely due to earlier tax-related challenges. Given the relatively low correlation of Indian G-Secs with global bond yields, we believe these measures will support healthy FPI inflows over time.
With the introduction of a more favorable tax regime for G-Secs compared to corporate bonds, we may see a near-term shift by FPIs from AAA-rated corporate bonds to G-Secs, which now offer better carry on a tax-adjusted basis.
Over time, we also expect the inclusion of Indian G-Secs in the Bloomberg Global Bond Index, which could lead to more consistent and passive inflows of around USD 25–30 billion over a 12–18 month period following the announcement.
Such index inclusion would strengthen and deepen foreign investor participation in the Indian bond market. It would also place Indian G-Secs firmly on the global investment map, potentially triggering sustained structural inflows over the longer term.
Q) Could increase FPI participation in government securities provide structural support to the rupee?
A) Higher FPI participation in government securities can provide structural support to the rupee over time, although it may not serve as an immediate fix. The recent underperformance of the currency has been driven by a combination of elevated energy prices and FPI outflows from domestic markets.
Policy measures such as FCNR(B) mobilization, increased ECB inflows, and steps to accelerate export proceeds can help alleviate near-term external vulnerabilities. In this context, greater FPI participation in government bonds becomes an important structural factor, as it can create a
more stable and diversified source of capital inflows.
To the extent that these flows materialize, they can help offset pressures on the capital account and reduce reliance on more volatile equity portfolio flows. This, in turn, would improve overall balance of payments dynamics and provide the rupee with a much-needed buffer against external shocks.
In summary, while global factors will continue to drive short-term currency movements, deeper foreign participation in the bond market is a clear medium-term positive for rupee stability.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
