SBI Funds Sees Muted Foreign Flows into Indian Bonds Despite Tax Relief

The assessment comes as SBI Funds expects the Reserve Bank of India to stay on an extended pause on interest rates. The RBI's August monetary policy statement, the report noted, kept the one-year-ahead consumer price inflation projection at 5.3% and average headline inflation for FY27 at 5%. The central bank pointed to core inflation running around its 4% target, which SBI Funds said provides room to keep rates unchanged.

"The policy stance seems to suggest a prolonged pause on policy rates with normalisation of policy rates likely to be pushed out further," SBI Funds said. The repeated emphasis on core inflation, the report argued, also indicates a greater tolerance for headline inflation staying above the 4% target, even as the RBI has reiterated its medium-term objective.

Global interest rates pose another headwind. SBI Funds said weaker fiscal conditions and inflation above target in several developed economies could keep global bond yields elevated for a while longer. "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.

That means domestic interest rates will receive little support from external flows in the near term, the fund manager concluded. The muted outlook for foreign portfolio investment in bonds contrasts with the government's hopes that the tax removal would draw in capital to help fund the fiscal deficit. For now, the combination of index exclusion, a dovish-leaning RBI, high global yields, and a rupee that remains under pressure against the dollar keeps the threshold for sustained inflows high.