Foreign investors sweeten on Indian government bonds as equities see a sell-off

Foreign investors appear to have soured on Indian stocks, but they are turning increasingly positive on the country's bonds, ahead of a possible inclusion in the Bloomberg Global Aggregate Bond Index.

India last month scrapped tax on overseas bond investors, clearing the path to its inclusion in the Bloomberg Index, as it seeks to attract foreign capital, experts said. While an update on this is expected soon, the actual inclusion is expected to happen in early 2027.

India could get a weightage of about 0.7% in the index, and this is estimated to lead to flows of "$25 to $27 billion," by financial year 2028, Ashish Vaidya, head of treasury at DBS Bank, said on CNBC's "Inside India" last week.

Foreign investors have purchased $7.7 billion in Indian debt so far this year, surpassing the $6.6 billion for the entire 2025, according to data from Indian depository NSDL.

And $5.8 billion of those inflows were just in June after India cut the 12.5% long-term capital gains tax and the 20% withholding tax on interest income for foreign investors buying government bonds.

Meanwhile, foreign investors have sold direct equities worth $27.6 billion in 2026 so far, as Indian stocks lost their appeal amid an AI-driven momentum in global markets.

India also included government securities with maturities of 15, 30, and 40 years under the "fully accessible route," which has no investment caps on purchases. In June, under the fully accessible route, India received monthly foreign inflows of $2.3 billion — the highest in the last 14 months.

Expansion of the FAR bonds universe to include longer-tenor issuances could draw interest from foreign insurance and pension funds that have "longer duration demand," HSBC said in a note last month.

Tax exemption for foreign investors buying Indian government bonds is "truly a gamechanger," Tanveer Sethi, senior executive vice president of investment management at Kotak Mahindra Asset Management Singapore, told CNBC.

Index inclusion is a "natural and intended consequence of the tax reform," he said, adding that the current inflows are from tactical investors and a few active investors who are taking positions ahead of the inclusion.

Following the index inclusion, some of this money will change hands from these tactical investors to the passive ones, experts said.

Equity outflows, coupled with a rising import bill due to higher global oil prices, have pressured government finances and the rupee.

India's balance of payments deficit widened to $23.6 billion in the financial year ended in March 2026, from $5 billion a year ago. For April and May, the deficit was $11 billion due to the continued capital outflows and energy price shocks. Bond inflows will help narrow that gap and shore up the rupee.

A previous inclusion of Indian bonds to JPMorgan Government Bond Index-Emerging Markets (GBI-EM) in 2024 resulted in net inflows of up to $20 billion, Gaura Sengupta, chief economist at India's IDFC First Bank, told CNBC.

Unlike the earlier case, the Bloomberg Index includes both emerging and developed markets, so Indian bonds need to stand out, she added. The move to abolish tax for overseas bond investors has reduced the compliance costs and improved ease of doing business, Sengupta added.

Bloomberg is already laying groundwork for the internationalization of India's government bond market. Last week, it launched an "electronic trading workflow" for Indian government bonds that enables foreign portfolio investors to "access liquidity provided by international and domestic banks through the Bloomberg Terminal."