By Patturaja Murugaboopathy and Gaurav S Dogra

(Reuters) - Foreign investors stepped up their investments into Asian domestic bond markets in the first half of the year, but analysts expect the pace of inflows to drop off for the rest of the 2017 as global interest rates rise.

Indian bonds led the region with inflows of about $4 billion in June taking the total for the first half to $14.73 billion, a record for the January-June period of any year.

Inflows into South Korean bonds rose for the sixth straight month in June, while Indonesian bonds also received inflows for a seventh straight month.


Analysts said the huge first half inflows were mostly due to the unwinding of outflows that happened in late 2016. Data from central banks and local bond market associations in India, Indonesia, Thailand, Malaysia and South Korea showed foreigners net sold $15 billion in these bond markets in the second half of last year.

"The bond inflows we have seen in the first half have been very strong. It is going to be very difficult to sustain those kinds of inflows," said Khoon Goh, head of Asia research at ANZ in Singapore.

"Over the second half of this year, we have the (Federal Reserve) starting to normalize their balance sheet, and potentially other major central banks in the world could be looking to remove accommodation. So we will start to see an easing of inflows in the second half of this year," Goh said.

On Wednesday, the Bank of Canada raised interest rates for the first time in nearly seven years saying the economy no longer needed as much stimulus, while Fed Chair Janet Yellen said interest rates hikes would be gradual and that the U.S. central bank may not be able to raise rates by "all that much."

Malaysian bonds saw meager sales of about $70 million in June after witnessing positive flows in the previous two months. The second quarter of the year was a turnaround for Malaysian bond markets as foreigners returned, purchasing bonds after dumping them between November 2016 and March this year due to a central bank's crackdown on the onshore ringgit trading market.

Overall, analysts expect some outflows in the second half of the year, but they reckon the threat to the regional currencies would not be severe as it was during taper-tantrum, when the U.S. Federal Reserve first hinted that it might taper its monetary expansion policy.

Improved foreign reserve buffers in China, Hong Kong, Taiwan, India, South Korea and Southeast Asia, which rose by $153 billion to $5.4 trillion in the first half, will help calm the markets, UOB said in a report.

"As such the region has a stronger war chest of reserves to support their currencies."

Analysts also said some bond inflows could be expected in countries such as India and Indonesia where interest rate cuts are expected later this year.

"A rate cut will be bullish for bonds because it will push bond prices high which will make it attractive for investors," said Goh.

(Reporting by Patturaja Murugaboopathy and Gaurav Dogra; Editing by Sam Holmes)

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