Liberalised investment limits have not stemmed FPI exodus from Indian debt

| Updated on April 09, 2020

Perhaps this shows that bulk of these investors are of the speculative and not fundamental variety, who were essentially looking to make quick gains from betting on rate arbitrage

In a bid to win India a berth in global bond benchmarks, the Indian government has pulled out all stops to encourage foreign investment flows into the debt markets in the last couple of years. It has significantly raised the debt investment ceiling for foreign portfolio investors (FPIs), permitted more short-maturity investments and doubled limits under the Voluntary Retention Route, which waives residual maturity and concentration norms for FPIs. Such liberalisation moves though, have been of little help in shielding the Indian bond market from the recent FPI stampede out of emerging markets following the Covid crisis. March 2020 saw the largest ever sell-off by FPIs with pull-outs totalling to ₹60,000 crore; nearly twice the levels seen during the June 2013 taper tantrum. After lobbying for higher investment quotas when the times were good, FPIs are now using up barely 37-40 per cent of their quotas in Indian bonds, with ‘long-term’ FPIs using up less than a fourth of their limits. With foreign investors now accounting for a significant proportion of the trading activity, their concerted selling has caused considerable turmoil in Indian debt markets in March, spiking up yields for even high-quality issuers and drying up liquidity, requiring the RBI to intervene.

Ironically the latest FPI exodus from Indian bonds unlike the one in 2013, has transpired at a time when India’s external fundamentals measured by its trade balance, forex reserves and foreign debt, are on a particularly strong footing. Thanks to the oil price collapse, the current account deficit is now projected at a near-zero level for FY21, India’s external debt is at less than 20 per cent of GDP and its record forex reserves provide a comfortable 12-month import cover. That FPIs investing in local bonds should still lump India with all other emerging markets and indulge in panic sales when risk aversion hits, perhaps shows that the bulk of these investors are of the speculative and not fundamental variety, who were essentially looking to make quick gains from betting on rate arbitrage.

Overall, the recent outflows suggest that, given the lack of depth and breadth in the domestic bond market, policymakers must perhaps focus more on the quality of foreign investors in it, rather than chase numbers through higher quantitative limits. Over the past decade, SEBI’s strict vigilance on KYC norms and transparent structuring of registered FPIs investing in Indian equities, has materially improved the quality of such investors in Indian stocks with more sovereign wealth funds, pension funds and venture capital funds replacing opportunistic investors like hedge funds. The bond market may benefit from a similar initiative. The Centre also needs to do a better job of showcasing India’s good external debt credentials to overseas investors and global rating agencies, rather than harping on the $5 trillion GDP target. A stronger legal framework for debt recovery, a vibrant onshore currency market and a better sovereign rating for India from global agencies are necessary too.

Published on April 09, 2020

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