India Economy

Ways to lure FIIs to debt

S. J. Balesh | Updated on January 18, 2014 Published on January 18, 2014

Current yields are attractive for global investors. — Africa studio/

What India needs is a stable and forward-looking policy regime to attract long-term capital.

At a recent Reserve Bank of India’s post policy conference call with researchers and analysts, the officials indicated their preference to seek out long-term real money investors in the Indian debt markets as compared to what is called “Bond Tourists”.

All these years, debt inflow into India has been characterised by predominant flows from the global banking system and asset management companies with limited interest from long-term real investors, namely, pension, endowment and sovereign wealth funds.

The easy money following the global financial crisis resulted in strong inflows into high-growth emerging markets.

In India, while the inflows helped fund the high current account deficit, they also made the country complacent about its capacity to continuously fund the high current account and fiscal deficits.

Fed tapering

The possible tapering of asset purchases by the US Federal Reserve had a strong impact on the Indian markets across asset classes.

The Indian rupee was among the worst affected asset classes with the rupee/dollar USD/INR pair, which from was at around Rs 53.50 to a dollarUSD a year ago touched a record an all time low of around Rs 68.85.

The prime culprit behind the currency depreciation is the strong FII debt outflow and a slowdown in ECB inflows. During the June-October 2013 period, FII debt outflow aggregated almost Rs 71,500 crore, the largest since throwing open the Indian debt market to the FIIs. While the temporary measures taken by the RBI have helped stabilise the rupee, the postponement of the tapering timeline has provided India with breathing space to set its house in order.

Given the investment opportunity that a large capital-deficit and high-growth-potential country like India provides, the country should be able to attract a larger proportion of the global pool of assets under management, estimated to be around $110 trillion (both debt and equity).

Even a small increase in allocation of funds into India would entail a much larger inflow into the country.

Given the low interest rates globally, yields prevailing in India would definitely be attractive for international investors.

However, what the country needs is a stable and forward-looking policy regime as well as a transparent operating framework that can attract long-term capital on a sustainable basis.

Therefore, the focus of India’s regulatory regime, including fiscal and tax incentives, should be on attracting international flows from long-term players. Two measures that could help are:

Reduce the withholding tax rate for long-term investors: The latest Budget reduced the withholding tax rate on interest payments on bonds, both corporate and Government Securities held by FIIs, to 5 per cent. However, this has been made applicable only for interest payments for the next two years.

While seeking long-term funds, offering lower withholding tax only for two years could be counterproductive. Therefore, the Government needs to take a re-look at this tax, allowing lower or nil withholding tax for longer period investments.

Any reduction in the withholding tax rate would broaden the investor base, especially real money investors, and need not be a major revenue loss for the country as in the past investors have used structures and double taxation treaties to reduce their tax incidence.

INR denominated bonds in the overseas market: Another option is allowing Indian corporates to issue INR denominated bonds in the global markets.

According to this structure, the bonds would be listed and traded in the overseas markets, thereby providing comfort to the international investors on the settlement mechanism. From the country’s perspective, it serves the twin purpose of reducing the exchange rate risk borne by Indian corporates, as investors would assume the exchange risk. It would also curb speculative flows resulting in better exchange management. Investment in such bonds could be a first step for many international investors before investing in the domestic debt markets.

Being part of a dynamic market environment with many emerging markets competing for the same pool of funds, India needs to reinvent itself to be able to attract offshore investment pools to fund its large investment requirements.

(The author is Senior Director – Resources, IDFC.)

Published on January 18, 2014
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