RBI Warns Unwinding of Leveraged Hedge Fund Positions During Stress Could Roil Bond Markets

Mumbai, June 30: The Reserve Bank of India (RBI) on Tuesday cautioned that the growing presence of large and leverage hedge funds in the sovereign global bond market could heighten financial stability risks, warning that a rapid unwinding of their positions during periods of market stress may trigger fire sales and broader market spillovers.

In the June Financial Stability Report (FSR), the central bank said the footprint of price-sensitive leveraged investors, including hedge funds, in sovereign bond markets is increasing, making these markets more vulnerable during episodes of heightened volatility.

The RBI noted that large and leveraged hedge funds are increasingly engaged in sovereign bond arbitrage trades, including cash-futures basis and swap spread trades, using high levels of leverage.

“Therefore, in periods of market stress, these funds could rapidly unwind their positions and increase the risk of fire sales and broader market spillovers,” the report said.

The central bank said these risks come at a time when sovereign debt remains elevated globally and government bond yields have risen sharply, increasing refinancing pressures on governments.

The report noted that higher borrowing requirements and elevated debt levels have made sovereign bond markets more susceptible to shifts in investor sentiment. The growing participation of leveraged investors could amplify market volatility if liquidity conditions tighten or risk appetite weakens.

Amid rising global debt levels, rollover risks are increasing as governments have substantially shortened the maturity profile of their debt in the recent period, thereby increasing refinancing requirements, the RBI said.

Sovereign debt, already at elevated levels, continues to increase at a time when the global economy is facing growth headwinds and increasing debt servicing costs. Beyond existing debt burdens, government deficits could widen as higher yields raise interest costs and efforts to mitigate the impact of elevated energy prices increase borrowing needs, RBI added.