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Radhika Menon

Mumbai, Nov. 3 Foreign institutional investors have till date trebled their investment in the country’s debt market in the current calendar year, as compared to the same period last year.

They have invested $1.596 billion in the current year, against $487 million in the corresponding period last year. Dealers attribute the increased flow to the interest differential between returns on rupee and dollar investments. In the past 10 months, interest rates in the US have been easing, and Indian bond yields have stayed high. The strengthening of the rupee against the dollar has provided the icing on the interest arbitrage cake.

“The upgrade of India’s sovereign rating to investment grade and the improvement of the country’s macro situation and growth fundamentals have meant that FIIs have been quickly filling up their investment limits in debt. India is offering a better credit environment than some of the other international markets,” said Mr Rajeev Ahuja, Head-Fixed Income, Capital markets, Citigroup.

On a fully hedged basis, the cost of funding for an FII is currently 5.5 per cent (based on the Mumbai Inter bank Forward Offer Rate for two years) while the return on a two-year government paper is 7.7 per cent. The arbitrage opportunity works out to be a little over 2 per cent.

“Most FIIs invest in one- to three-year paper. The interest rate differential has meant they are getting good returns,” said Mr Prakash Subramanian, MD, Capital Market, South Asia, Standard Chartered Bank.

September and October saw the highest inflows during the calendar year at $652 million and $616 million respectively. “September and October saw the cost of funds falling (MIFOR) and the bond yields increasing,” said a senior treasury official at a foreign bank.

While many FIIs hedge themselves, the fall in forward premia on dollars has reduced the cost of hedging as well. Some FIIs have now begun doing away with hedging, as they are bullish about an appreciating rupee. The premia on a 12-month forward is currently at 1.1 per cent, against 1.8 per cent a year ago. Lower premia in the forward market implies a stronger rupee and a weaker dollar.

According to a treasury official at a foreign bank, SEBI has been proactively reshuffling FII-specific entitlements and this has helped institutions with a greater appetite for Indian debt paper to hike their exposure.

“While some FIIs fully utilise their individual limits, others don’t. Two years ago, it was rare to see SEBI reallocate the FII limits. But the capital market regulator is now doing so in favour of the more active FIIs once every few months,” said a senior treasury official.

The aggregate limit on FII investments in debt currently stands at $3.2 billion for government securities and $1.5 billion for corporate debt. Treasury officials say any hike in the corporate bond limit is fully utilised in a matter of a few days, as the returns are better in this segment.

More Stories on : Debt Market | Foreign Institutional Investors

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