India among the least impacted fundamentally from the bond market sell-off": Credit Suisse,

● Given the euphoric sentiment in bond markets until May (Figure 1), a
correction was overdue, in our view. EM sovereign bond prices are
down 4.1% from peaks, back to levels where QE3 started. They could
fall 2.7% more, if they revert to levels where expectations of QE3
started. That said,CS economists don’t expect a stoppage to QE3 until
end-CY14.
● This sell-off could affect growth in EMs by affecting cost of capital.
Given India’s (relatively) closed debt markets, less than 5% of
bonds are foreign owned, much lower than other EMs (Figure 2).
This limits the impact on the broader economy: India’s yields have
risen the lowest since the sell-off started (Figure 3).
● But India would still be badly impacted if capital flows to EMs slow
structurally: mainly through the currency, given the precarious
BoP situation. A weak INR drives higher inflation, further stresses
government finances, and thus impacts RBI’s ability to cut rates.
● But with a lot of bond market selling behind us, unless a crisis
emerges somewhere, a further exodus of capital is unlikely except
in the very near term. We remain cautious on growth in India, but
won’t be surprised if the market rebounds.

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Global bond sell-off: How much more to go?
Given the unidirectional moves in bond prices globally over the past
two years or so (Figure 1), some correction was overdue, in our view.
EM sovereign bond prices are down 4.1% over the past month, and
market commentary indicates the reason is the US Federal Reserve
tapering QE3. EM government bond prices are back at Sep-12 levels
when QE3 started. This bond sell-off has impacted currencies, and is
now driving a sell-down in the equity markets as well. The question is,
how much more to go before QE3 stoppage gets priced in?
Speculation on QE3 began in Jun-12, so if expectations were to revert
to those levels, bond prices would fall another 2.7%. Credit Suisse
economists do not believe a complete stop to bond buying by the Fed is
likely before end-CY14, but the overshoot may take bond prices there.
India’s exposure to the sell-off not through yields
FIIs have net sold US$3.6 bn of Indian bonds since 22 May: the past 15
days of continuous bond selling by FIIs is the longest streak ever seen.
Yields have also inched upwards (GSecs: +17 bp; AAA Corp +52 bp). But
given India’s (relatively) closed debt markets and caps on FII limits
(US$30 bn for government and US$51 bn for corporate bonds), less than
5% of bonds in India are foreign owned, much lower than other EMs
(Figure 2). This limits the impact of FII selling on yields, and prevents
broader impact on the economy through directly higher cost of capital.

Capital dependency causes volatility, not crisis (yet)
But that does not mean India will not be hurt if capital flows to EMs
slow. Transmission in India is likely to be through the currency: given
a high CAD (current account deficit), a blip in global capital flows
stresses India’s balance of payments. This drives higher inflation,
further stress on government finances, and thus impacts RBI’s ability
to cut rates.
Thus, we need to be concerned only if the contagion were to spread
to FII equity investors and in particular if some crisis emerges that
slows all cross-border capital flows: past episodes of FII equity
investors’ net selling coincided with global crises. While the moves in
currencies and bond yields may be reminiscent of such trends, there
isn’t yet any impending problem of a bank blowing up, a currency
union dissolving, or an EM declaring bankruptcy