Fresh foreign funds flows are bound to increase as a fall out of the Reserve Bank of India (RBI) 0.5 per cent hike in key short-term policy rates.

Huge difference in yields between Indian sovereign funds and US dollar treasury paper may trigger fresh foreign fund flows. Yield difference between the two instruments is about 800 basis points for one year tenure and above instruments.

The yield on ten-year security firmed slightly to 8.37 as against last weekend’s level of 8.31 per cent. The firm rates though were still lower than the 10-year yield during the current financial year. The ten-year yield had touched 8.43 per cent on May 27, this year. But, the firm yields were still lower than the weighted average yield of 8.38 per cent for the current year so far.

Bank of Baroda chief economist Rupa Nitsure said, “These differentials are attractive and should substantially help in supporting cross border inflows.”

This high yield differential explained the surge in foreign institutional investor flows. FIIs brought in $2.51 billion this month so far as against $1.083 billion in June and against net outflow of $947 million in previous month. For Bank of Baroda, the inflows are good, since foreign exchange is large component of our business, she added.

Traders said foreign banks mostly drove fresh inflows. For the foreign banks, US dollar liabilities were cheap and parking them in low risk Indian debt was a high yield game. Typically, foreign banks support FIIs by purchasing their dollar and meeting their Rupee liquidity requirements. The dollars purchased are in turn swapped with other banks including public sector banks for rupee liquidity for short durations, ranging from overnight to three months.

Traders said that swap funds were in turn parked in government securities or in collateralised borrowing and lending obligations (CBLO) markets. The purchases in turn helped keep bond yields under check.

But, preference was high for the CBLO (inter-bank lending or borrowing against a collateral of government/other eligible securities) for liquidity purposes. This kept the CBLO rates lower than the new repo rates of 8 per cent. The CBLO rates were least 65 basis points lower.

Clearing Corporation of India chief forex officer Indrani Rao said, “Foreign fund inflows are already happening in the equity markets. Obviously with the sovereign debt yields at current levels, short term foreign fund inflows are bound to increase with attendant impact on forward premiums.”

shivkumarc@mydigitalfc.com