Whalesbook
RBI Rules Drive Up Investor Hedging Costs
Reserve Bank of India (RBI) actions to stabilize the rupee have inadvertently made it much harder for foreign bond investors. This has wiped out the yield advantage of Indian government bonds. One-year onshore hedging costs have risen by about 30 basis points since the RBI's actions, while costs in the offshore Non-Deliverable Forward (NDF) market have climbed even more, nearly 70 basis points. NDF hedging costs hit their highest point in over a decade shortly after the RBI's policy changes. Liquidity in the NDF market, key for foreign investors managing rupee risk, has shrunk, making hedging more expensive and difficult. These higher hedging costs cancel out returns from Indian government debt. 'Investors are being paid much less for the risks they take,' said Matthew Kok, a portfolio manager at Eastspring Investments. Eastspring, which manages around $280 billion, holds a neutral view on Indian bonds.
Oil Price Hikes Worsen Stock Valuation Concerns
Alongside currency hedging issues, rising oil prices from the conflict in Iran are worsening existing worries for stock investors. India imports about 90% of its oil from the Middle East, making its economy especially vulnerable to supply disruptions and price swings. Brent crude oil has climbed to around $91.50 per barrel. These higher energy costs worsen existing problems, such as high stock valuations and slowing company profit growth. Foreign investors have already pulled significant amounts of capital, divesting about ₹211 billion ($2.26 billion) of Indian government debt since February 28, with sales speeding up after the currency rules were announced. Equity outflows have been larger, totaling an estimated $38 billion since the start of 2025, including a record $12.7 billion in March alone. The benchmark Nifty 50 index has fallen over 7% year-to-date, trading at around 23,850 points.
Policy Risks and High Valuations Cloud India's Outlook
India's market appeal is facing growing challenges from policy-related costs and fundamental valuation concerns. The RBI's currency strategy, intended for stability, has structurally raised hedging expenses, directly cutting net returns for foreign bondholders. This policy risk is a clear deterrent. Furthermore, India's stock market trades at a high valuation premium, with a forward price-to-earnings (P/E) ratio of about 23x, well above the emerging market average of roughly 19x. This premium makes the market vulnerable to further drops, especially as company profits face pressure. Brokerages have started revising forecasts downward; Goldman Sachs confirmed a cumulative 9 percentage point reduction in its India earnings growth forecast for the next two years. Nomura warns of a potential 10-15% downside risk to consensus earnings estimates if oil prices remain high and has already cut its December 2026 target for the Nifty 50 index by 15% to 24,600. The current 10-year Indian government bond yield is about 7.15%, which, combined with hedging costs, offers meager returns relative to the perceived risks.
Investor Caution Could Linger Despite Easing Tensions
Even if immediate geopolitical tensions ease, sentiment toward India may not bounce back quickly. Nigel Foo, head of Asian fixed income at First Sentier Investors, pointed to ongoing concerns about currency stability, suggesting higher bond yields may be needed to restore foreign investor confidence. He noted that a quick shift in sentiment is unlikely, even if oil prices fall, because of lingering currency risks. This cautious outlook is seen in portfolio choices. Aberdeen Investments notes most of its Asia and emerging market equity funds are underweight Indian stocks, even with positive long-term views. The trend of foreign capital outflows, seen in March and continuing into early April, highlights hesitant sentiment and increased investor scrutiny on how currency policy and geopolitical events affect India's investment attractiveness.