Foreign investment in Indian bonds slumps amid rupee weakness, US trade deal uncertainty

Core Viewpoint - Indian sovereign bonds are experiencing significant outflows due to a weaker rupee and indications that the central bank is nearing the end of its interest-rate cut cycle, leading to negative sentiment among investors [1][5]. Group 1: Outflows and Market Impact - Global funds have sold ₹14,300 crore ($1.6 billion) of Indian bonds in December, marking the largest outflow since the Fully Accessible Route was established in 2020 [2]. - The outflows are contributing to the largest monthly decline in Indian bonds in four months, exacerbated by heavy state debt issuance and rising government borrowing costs [5]. - The rupee has weakened significantly, testing record lows against the dollar, which has negatively impacted returns for foreign investors [3][6]. Group 2: Investor Behavior and Currency Performance - Foreign investors are reallocating their investments to emerging markets with higher yields and better currency appreciation potential, with the rupee being the worst-performing major emerging market currency in 2025 [4]. - Year-end profit-taking has led to further foreign selling as investors adjust their bond holdings and engage in interest-rate derivative trades following a rise in swap rates [6]. Group 3: Future Prospects - Potential developments in 2026, such as a US trade deal, could revive foreign interest in Indian bonds by easing pressure on the rupee through lower tariffs [7]. - The inclusion of Indian securities in more global bond indexes next year may increase foreign demand for Indian debt, with expectations of inclusion in the Bloomberg global index [8].