Synopsis

Foreign investment in Indian government bonds is projected to stay subdued as global yields alongside domestic interest rates reduce investor attraction. The postponement of India's inclusion in global bond indices further curbs foreign portfolio investments. The Reserve Bank of India is anticipated to keep interest rates steady for a considerable duration, with heightened global yields providing minimal support to local interest rates.

Foreign investment flows into Indian government bonds are likely to remain muted in the near term despite the removal of taxes on overseas purchases of sovereign bonds, as global yields, the domestic interest rate cycle and rupee expectations weigh on investor interest, according to SBI Funds Management.

In its Market Outlook for August 2026, SBI Funds said the deferment of India's inclusion in a global bond index could also limit incremental foreign portfolio investment in Indian bonds.

"With the index inclusion being deferred, one should anticipate muted incremental flows into Indian bonds in the near term from FPI's," the report said.

The report said the tax relief by itself may not be sufficient to substantially improve foreign demand for Indian sovereign bonds.

"Even with the removal of taxes on overseas purchases of sovereign bonds, relative yield differential and the current state of the policy cycle and INR expectations do not provide much comfort with respect to prospects of debt flows," SBI Funds said.

"Flows if any would be tactical in nature with currency expectations possibly guiding these," it added.

The assessment comes as SBI Funds also expects the Reserve Bank of India to remain on an extended pause on interest rates, with any normalisation of policy rates likely to be pushed further out.

Analysing the RBI's August monetary policy guidance, the report said that while the one-year-ahead consumer price inflation projection remains at 5.3 per cent and average headline inflation for FY27 is projected at 5 per cent, the central bank's reference to core inflation being around its 4 per cent target provides room to keep rates unchanged.

"The policy stance, seem to suggest a prolonged pause on policy rates with normalisation of policy rates likely to be pushed out further," SBI Funds said.

The report said the RBI's repeated emphasis on core inflation also indicates a greater tolerance for headline inflation remaining above the 4 per cent target, even as the central bank has reiterated its medium-term inflation objective.

Global interest rates, meanwhile, remain another challenge for foreign flows into Indian bonds. SBI Funds said weaker fiscal conditions and inflation remaining above target in several developed economies could keep global bond yields elevated.

"Weaker fiscal direction as well a prolonged period of above target inflation in most developed markets continues to support the case for higher global yields for a while longer," the report said.

It added that domestic interest rates are therefore likely to receive little support from external flows in the near term.

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