Avoid micromanagement

After jostling to accommodate their sovereign and corporate bond exposures within tight regulatory limits, Foreign Portfolio Investors (FPIs) have been distinctly cool to Indian bonds in the last one year. A BusinessLine study shows that FPIs, after utilising over 82 per cent of the RBI ceiling on government securities in January 2018, used up just 57 per cent of the enhanced limit in January 2019. Nor were they enamoured by corporate bonds where their utilisation fell from 98 to 70 per cent. Worried about waning FPI interest, the RBI Governor is said to have held talks with global investors last week. The RBI has also hastened to lift the single-entity exposure limit of 20 per cent for FPIs in corporate bonds. But it is unlikely that foreign investors will throng back to Indian bonds in a hurry.

Trends in FPI debt flows over a decade show that India tends to attract global debt investors mainly of the short-term variety. As many of them hunt for arbitrage returns, global factors such as Indian rates vis a vis developed market interest rates, quantitative easing policies of global central banks and exchange rate outlook play a big role in deciding flows. Lately, FPI debt returns have been hit both by shrinking rate differentials and a volatile Rupee. After peaking at over 8.1 per cent in September 2018, India’s 10-year gilt has seen its market yield decline to 7.4 per cent this month, even as US treasury yields have hovered at 2.7 to 3.2 per cent in this period. Volatile oil prices and unclear rate signals from the MPC have made directional calls on rates difficult. Return prospects for FPIs betting on India are further muddied by an erratic Rupee, which weakened 6 per cent against the dollar in 2018. The series of credit events roiling debt markets after the IL&FS debacle is likely to have rattled foreign investors too. While market conditions have been none too conducive, the RBI’s regulatory interventions have further complicated FPI decisions by sending out garbled signals. After moving from a fixed to a floating cap to encourage FPI participation in domestic bonds, RBI first sought to micromanage these exposures by stipulating sub-limits within each security/category and setting minimum residual maturity and concentration norms. In the last few months, as FPI flows became critical to fund the widening trade gap, it has been on a rollback spree to dilute some of these rules.

Given that there is little that the central bank can really do to bolster the return prospects for FPIs, it is best that it refrains from opportunistic rule changes and works at providing a stable policy regime for foreign investors, that bolsters the long-term health of the bond market. Structural reforms that address the lack of breadth, depth and quality issuances in Indian debt market may do more to woo serious FPI money, than quick-fix tweaks with an eye on immediate flows.

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