By Saumya Vaishampayan 

Investors are rushing into the bond markets of India and Indonesia, drawn by rich yields and the rosy growth prospects of countries that a few years ago were considered among the most vulnerable emerging markets.

The two Asian countries have together captured almost one-fifth of emerging-market bond net inflows this year through August, according to data from the Institute of International Finance, a trade group.

Prices of government bonds in both countries have rallied in recent months. That has brought yields down, though they remain higher than those for equivalent bonds in the U.S. and Europe. The yield on India's 10-year government bonds has fallen to 6.619% from 6.711% six months ago, when more than $1 billion in net flows started pouring into the country's debt market. Bond yields fall when their prices rise.

In Indonesia, the 10-year bond yield has fallen to 6.310% from 7.094% in the past six months. That yield was nearly 8% at the end of 2016, following heavy outflows from emerging markets after Donald Trump won the U.S. election.

As with any popular trade, the worry is that the first sign of trouble could send investors running, especially in countries where they hold sizable bets. Such shocks could come from a faster-than-expected pace of U.S. interest rate increases, or a slowdown in Chinese growth, analysts say.

"When volatility in the market comes back, those are positions that are probably the first ones to be hit," said Roland Mieth, emerging-markets portfolio manager at Pacific Investment Management Co. in Singapore.

Four years ago, foreign investors started dumping Indian and Indonesian debt after the U.S. Federal Reserve indicated it would gradually wind down its bond-buying program, part of the so-called taper tantrum in emerging markets that year.

Swift reversals in the foreign-exchange market may also pose a risk for investors who own local-currency debt. The Indian rupee is the most crowded currency in Asia and the fourth among emerging markets globally, according to Bank of America Merrill Lynch. The rupee has advanced more than 4% against the dollar so far this year.

Signs that U.S. and European central banks are preparing to reverse loose monetary policy haven't triggered lasting routs in Indian and Indonesian bonds. Indian bond yields rose last Thursday after the Fed said it would start shrinking its bond portfolio, as expected.

One reason for investor steadiness is that long-term institutional investors are increasingly investing in Indian and Indonesian debt, as opposed to shorter-term investors like hedge funds, said Rob Subbaraman, chief economist, Asia ex-Japan at Nomura.

Investors say they're also banking on the success of economic overhauls in both countries. The World Bank's distance-to-frontier gauge, which measures changes in regulatory environment for local businesses in different countries, has signaled improvement for India and Indonesia in recent years.

Nonresident investors bought a net $2.72 billion of Indian sovereign and corporate debt in August--17% of total emerging-market bond inflows--according to the Institute of International Finance. Those investors plowed a net $907 million into Indonesian bonds last month. For the year, investors have poured a net $20.2 billion and $9.1 billion into Indian and Indonesian debt markets, respectively.

With the influx of cash, foreign ownership of rupiah-denominated Indonesian government bonds rose to 39.5% at the end of the second quarter, the highest in two years, according to data from the Asian Development Bank.

Foreign ownership of Indian bonds is quite low--4.2% as of July, according to ANZ--because of limits imposed by the country's central bank.

Ken Hu, chief investment officer for Asia-Pacific fixed income at Invesco in Hong Kong, says he has been participating in Indian government bond auctions almost every week as he tried to add to his holdings of local-currency debt in the country.

He says efforts such as Indian Prime Minister Narendra Modi's goods and services tax, which replaced a complex system of state and local taxes with a type of value-added tax, and Indonesian President Joko Widodo's campaign to boost Indonesian manufacturing are reasons why he likes bonds in both countries.

Jon Emont contributed to this article.

Write to Saumya Vaishampayan at saumya.vaishampayan@wsj.com

(END) Dow Jones Newswires

September 26, 2017 02:10 ET (06:10 GMT)

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