FAR bonds lose their pull as tailwinds fade

The moderation in foreign inflows into Indian government securities — specifically the Fully Accessible Route (FAR) bonds — marks a pivotal shift in India's capital account dynamics. To understand this, we must rewind to June 2024, when foreign portfolio investors (FPIs) poured over ₹25,000 crore into Indian G-secs in a single month, the highest in years. This surge was fueled by anticipation of India's inclusion in the JPMorgan Government Bond Index-Emerging Markets (GBI-EM), a milestone announced in September 2023 with a phased entry starting June 2024. The FAR route, introduced by the RBI in 2020, allows non-residents to invest in specified government securities without investment limits, making it the primary channel for such index-linked flows. However, the tailwinds are fading. The yield spread between India's 10-year benchmark bond (~6.95%) and the US 10-year Treasury (~4.30%) has narrowed to under 265 basis points — the lowest in over a year. This compression reduces the carry trade advantage that made Indian bonds attractive. Meanwhile, the US Federal Reserve's "higher for longer" stance on interest rates, reinforced by sticky inflation data, keeps dollar yields elevated. The rupee, hovering near 83.50/$, faces depreciation pressure from a widening current account deficit (CAD) and FPI outflows from equities. A weaker rupee erodes dollar returns for foreign bondholders, adding currency risk to the diminishing yield cushion. Key stakeholders include the RBI, which manages the FAR framework under the Foreign Exchange Management Act (FEMA), 1999; the Ministry of Finance, which sets borrowing calendars; global index providers like JPMorgan and Bloomberg; and foreign institutional investors (FIIs) such as pension funds and sovereign wealth funds. The RBI's dual mandate — price stability and growth — is tested as it balances rupee stability with the need for cheap foreign capital to fund the fiscal deficit (5.1% of GDP in FY25 BE). Constitutionally, Article 292 empowers the Union government to borrow on the security of the Consolidated Fund of India, while Article 266 defines the Consolidated Fund. The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 (amended 2018) mandates fiscal consolidation, making external borrowing a strategic tool. The RBI Act, 1934, under Sections 45U–45ZB, grants the central bank authority over capital flows and forex management. This development connects to broader themes: financial globalisation, monetary policy autonomy, and the "impossible trinity" — India cannot simultaneously maintain free capital mobility, a fixed exchange rate, and independent monetary policy. The current scenario reflects the tension between integrating with global bond markets and preserving policy space. Looking ahead, if the Fed delays rate cuts beyond Q4 2024, yield spreads may compress further, risking capital flight. The RBI may intervene via forex sales or tweak FAR eligibility to stabilise flows. For aspirants, this episode underscores the fragility of portfolio flows and the importance of deepening domestic institutional investor base (insurers, pension funds) to reduce external dependence — a key goal of the National Infrastructure Pipeline and Atmanirbhar Bharat.