Initial foreign investor interest in rupee bonds fizzles out

The weeks-long foreign investor interest seen in rupee bonds during September has fizzled out, perhaps due to the expectations of further tightening of monetary policy by the United States Federal Reserve and the strengthening US dollar against the other currencies.

In the five weeks since the end of September 7, foreigners were seen returning to rupee gilts or government bonds, through the week ended on September 28, with each week seeing higher accumulation of bonds than the previous week. 

During this period, the stock of rupee bills and bonds held by foreigners surged from a rupee equivalent of Rs.4.01 billion on August 31 to Rs.22.17 billion by September 28.  

However, this trend waned in the following week before stalling in the week after, the most recent data showed. 
For instance, in the week ended on October 05, the foreign holdings of rupee gilts rose by only 1.86 percent to Rs.22.56 billion before the growth stalled in the following week ended on October 12, when the value of bill and bond stock held by the foreigners didn’t move in rupee terms from the week earlier. 

The Sri Lankan authorities were buoyed by the initial interest seen in the rupee gilts by foreigners after years of decline and at one point after a brief increase in such holdings, the officials were even considering promoting foreign investments to Sri Lankan treasuries. 

Foreign interest in rupee bonds also corresponded with the renewed foreign inflows seen to local equities after years of net outflows, as foreigners returned to the Colombo Stock Exchange in the last couple of months.
It remains immediately unclear what caused foreigners to stop their buying spree of Sri Lankan treasuries in the last week, after significantly slowing in the previous week or if the last two weeks were an exception to the trend.   

One argument could be that the investors may have begun to favour higher risk-free returns from the US treasuries, of which the yields have risen to multiyear highs, due to expectations of relentless increase in the short-term rates by the US Federal Reserve. 

The benchmark US 10-year treasury yield is now trading above 4.0 percent, highest since 2008, after the hotter than expected inflation print for September came last week prompted the investors to raise their bets for a continuous increase in rates by the US Fed, more than previously anticipated.