The Government seems to have erred on the side of caution by not going ahead with a tax exemption proposal aimed at facilitating settlement of trades in Government Securities (G-Secs) by foreign investors on Euroclear.

Had the tax exemption materialised in the FY2023 Union Budget, it could have paved the way for the inclusion of G-Secs in global bond indices, luring global investors to invest in G-Secs.

The flip-side of the proposed move could have prompted the Government to delay a decision in this regard.

There is a fear that once G-Sec settlement becomes Euroclearable, the Reserve Bank of India’s (RBI) ability to control the yield curve may diminish as global investors, with deep liquidity pools, could impart volatility to domestic interest rates through their buy-sell transactions.

In this regard, it may be pertinent to recall what RBI Governor Shaktikanta Das had said in October 2020. He had emphasised that financial market stability and the orderly evolution of the yield curve are public goods and both market participants and the RBI have a shared responsibility in this regard.

As the yield curve is a public good, the interests of the economy will be better served if RBI’s ability to control the yield curve is not undermined. More so, when it needs to strike a golden mean between supporting growth, which is slowly taking root, and tamping down inflation amid the raging Covid-19 pandemic.

India’s central bank does not like volatility in the financial markets and prefers gradualism in the movement of interest and exchange rates.

Referring to proposals for allowing international settlement of G-Secs through global securities settlement systems such as Euroclear, G Padmanabhan, then Executive Director of RBI, in a 2015 speech had highlighted the possibility of downside risks such as liquidity getting fragmented.

He had cautioned that some of the FPIs currently operating in India may like to move off-shore and develop a parallel Government securities yield curve outside India.

Foreign portfolio investors (FPIs) owned only 1.81 per cent of the outstanding G-Secs aggregating Rs 82,35,318 crore as at September-end 2021, according to RBI data.

Morgan Stanley, in an October 2021 report, had assessed that index inclusion could trigger $170 billion in bond flows over the next decade, lifting Indian bond prices while lowering borrowing costs.

There is no disputing that the Government needs a diversified investor base for its bond issuances in the wake of domestic financial intermediaries, especially banks and mutual funds, developing fatigue with the continuous supply of G-Secs over the last two years.

So, yield-hunting FPIs could play a part in soaking up a part of the sovereign bond issuances if tax exemption is given to them for settlement of their trades in G-Secs on Euroclear.

However, foreign investors are fair-weather investors, who could dump G-Secs the moment they see a higher return on investment opportunity elsewhere or some stress in the Indian economy/ financial markets. This can have repercussions for domestic interest rates.

Hence, minimising the impact of volatile spillovers from offshore markets to onshore market will be uppermost in the minds of policymakers in the Government and RBI before the red carpet is rolled out for FPIs.

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