FY25 Inflows Driven by Index Inclusion
Strong inflows into Indian government bonds in FY25 were largely fueled by India's inclusion into JPMorgan's Government Bond – Emerging Market Index. This inclusion process concluded by March 2025. In the following fiscal year, FY26, the trend reversed dramatically. Just in the first three months of FY26, foreign investment in these bonds fell by over ₹31,000 crore, setting the stage for the full year's net outflow of ₹11 crore, a stark contrast to the ₹1.2 trillion inflow seen in FY25.
Why Investors Pulled Back
Foreign investors' decision to sell Indian bonds was mainly driven by profit-taking as global risk appetite weakened. This was worsened by a smaller yield advantage for Indian sovereign debt. The difference between the 10-year US Treasury and India's benchmark 10-year bond narrowed to below 200 basis points by April 2025. Meanwhile, rising inflation worries in the US, partly due to trade tariffs, pushed up US Treasury yields. This made Indian bonds less appealing, especially since domestic demand, expecting aggressive rate cuts, had already lowered yields in India. As of March 31, 2026, India's 10-year government bond yielded about 6.961%.
Geopolitical & Currency Pressures
Worsening geopolitical tensions, particularly the conflict in West Asia, discouraged foreign investment. These tensions pushed crude oil prices above $100 per barrel, sparking concerns about imported inflation and a widening of India's current account deficit (CAD). An estimated $10 rise in oil prices could increase the CAD by about 36 basis points. Higher crude prices also put significant pressure on the Indian rupee, causing it to depreciate by roughly 10%. By March 31, 2026, the USD/INR exchange rate was around ₹94.26 to ₹94.77, a slide that reduced returns for foreign investors. India's weighting in the JP Morgan index dropped from about 10% to 9% after other countries were added, further affecting investor mood.
Indian Bonds Less Appealing Than Alternatives
Although emerging market debt generally saw positive inflows and attractive yields (around 6.9% for EM bonds), India's government bond market experienced a significant reversal in FY26. The expected large inflows from India's JPMorgan index inclusion were overshadowed by domestic and geopolitical risks. While domestic investors are increasingly supporting emerging market debt, foreign portfolio investors (FPIs) exited Indian bonds. The shrinking yield gap between India and the US, combined with currency depreciation, made Indian debt less attractive on a risk-adjusted basis. This was especially true when compared to safer Western bonds or other emerging market options offering similar or better returns, given the general search for yield. Ongoing pressure on the rupee, along with inflation and CAD concerns, created a volatile environment that deterred foreign fixed-income investment, despite India's strong economic growth prospects.
What's Next for Indian Bonds
A cautious outlook for Indian government bonds is expected to continue as investors weigh significant debt supply against changing global economic conditions. Although India's inclusion in global bond indices was a positive structural development, its benefits in FY26 were canceled out by external shocks and currency swings. For foreign investor interest to recover sustainably, geopolitical tensions need to stabilize, crude oil prices must moderate, and the rupee's depreciation trend must reverse. Continued fiscal responsibility and effective monetary policy will also be key.