Foreign banks buy state bonds

Mumbai: Three banks snapped up almost 90 per cent of bonds sold by Indian state governments to foreigners, and turned them into derivatives, raising the prospect of more volatility in one of Asia’s best performing debt markets.

Several market participants involved in the sale said offshore units of Nomura, Standard Chartered and Bank of America Merrill Lynch bought about Rs 3,000 crore ($451 million) of the Rs 3,500 crore on offer in October, the first window for foreigners to buy in.

Much of that debt was then sold for a hefty fee as derivatives known as total return swaps to offshore clients keen for the bonds’ higher yields, compared with India’s already popular sovereign debt, and with similar guarantees.

In contrast, traditional buyers of the illiquid bonds are state banks, who hold the debt to maturity. India has been one of the most resilient emerging markets, with foreign buyers taking up about $9.7 billion of debt this year, nearly exhausting available limits on sovereign debt purchases.

Those purchases have helped domestic debt return 7.8 per cent so far this year, the highest in Asia, according to HSBC. Given that appetite and a need to expand its investor base, India let foreigners buy state bonds.

“The main objective of (RBI) in opening these limits is to attract diverse and new sets of investors to the Indian bond market,” said a senior foreign bank treasury official based in Mumbai.

“But if eventually the FII (offshore) units of the foreign banks in India get to corner the limits, elbowing out the long term investors, then that leaves open a big risk of these trades unwinding and disrupting the Indian debt market.”