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Informist, Friday, Aug 2, 2024

 

By Pratigya Vajpayee

 

MUMBAI - India's debt markets have been left puzzled by a decision to restrict the list of government securities that can be fully accessed by foreign investors, barely a month after the country made a quiet debut on global bond indices.

 

When Indian bonds became a part of the JP Morgan Emerging Market index suite on Jun 28, the anticipated deluge of foreign investment turned out to be a steady trickle that got absorbed into the market without a trace of volatility. Yet, the Reserve Bank of India said on Monday that subsequent 14-year and 30-year benchmark securities will no longer be added to the list of bonds available under the fully accessible route under which there are no limits on purchases by foreign investors. Outside this route, FPI investments in individual securities are 30% of their respective outstanding stock, subject to an overall limit of 6% of outstanding government bonds.

 

When details of the measure were first mentioned by Finance Secretary T.V. Somanathan in an exclusive interaction with Informist on Jul 24, he had cited it as a plan to prevent market volatility that can be caused by increased foreign participation. Still, the action taken by the RBI and the government is perplexing on multiple counts - the mechanics of the measure, the choice of tenors, and the timing of the announcement. The volatility-curbing step has come way before the market has tasted volatility, raising questions about the RBI's tolerance for even the orderly fall that bond yields have recorded recently. The fact that the RBI has been selling bonds in the open market has only fuelled speculation that it is looking to rein in bond bulls.

 

Since Jun 28, yield on the 10-year benchmark 7.10%, 2034 bond has fallen 10 basis points, aided by a 30-bps decline in US Treasury yields and proposed new norms for liquidity coverage ratio that will require banks to maintain larger holdings of liquid assets to meet regulatory requirements. Between Jul 8-19, the RBI sold bonds worth 61.2 bln rupees in the secondary market.

 

The amendment of FPI investment rules will hardly have an impact on foreign inflows, even in the 14-year and 30-year segments. FPIs can still buy unlimited amounts of the 37 securities which have already been made available under the fully accessible route.

 

FPIs will still have access to around 600 bln rupees each worth of subsequently issued 14-year and 30-year bonds, considering that the government allows the outstanding on a single paper to rise up to 2 trln rupees. Since Sep 22, when JP Morgan announced the inclusion of Indian bonds in its global index, FPIs have bought 1.13 trln rupees worth of gilts under the fully accessible route, including 14-year and 30-year bonds worth a total of 194 bln rupees. In other words, even after the restriction, FPIs have more investment room that they can use.

 

The toothless nature of the measure begs the question – why do it?

 

LOCALISING VOLATILITY

Traditionally, the RBI has favoured FPIs buying long-term debt rather than short-maturity papers as the latter are more likely to attract hot money. Long-term debt purchases are typically associated with stable, real money investors. In this context, it seems somewhat strange that the RBI has knocked the longest maturities out of the fully accessible route. Bonds left out of this route, although still open for FPI investment, will not get added to global indices which require listed securities to be accessible without any restrictions. Consequently, incremental passive flows from index-tracking FPIs will be even more concentrated in the 5-,7-, and 10-year segments that now remain under the fully accessible route.

 

A possible explanation for limiting FPI access to subsequent 14-year and 30-year benchmarks is that the RBI and the government would be looking to divert foreign flows to tenors where volatility is easier to address.

 

On their way in, FPI inflows can pull down the targeted points on the yield curve, causing distortions in extreme cases. If these distortions play out in long maturities, they would lower the returns earned by domestic long-term investors such as insurance companies and provident funds which typically invest in such papers. Compared to long-term bonds, the RBI is better equipped to arrest a fall in shorter maturity yields with open market operations, given that bulk of the securities in its 13.5-trln-rupee domestic bond portfolio have tenors of up to 7 years. Still, a smoother alternative would have been for the government to shift more of its borrowing to longer tenors if the situation warranted.  

 

Top brass in the finance ministry is more concerned about the yield curve getting distorted when FPI flows are on their way out. While there is little cause for concern during the initial 10-month period of index inclusion when FPIs are making allocations to India, there will eventually be a time when they adjust these allocations based on changing views.

 

For instance, around the 10% weight that Indian bonds will have in the JP Morgan index, a swing between going overweight or underweight by 2% could cause a net inflow or outflow of $10 bln-$12 bln, market participants estimate. Given that long-term bonds tend to be more illiquid, FPI outflows from this segment can cause greater damage. The RBI too, rarely buys such bonds under open market operations, possibly because of monetary policy implications of adding long-term assets to its balance sheet.

 

"Think of us as a shop, we are taking some goods off the shelves," a senior finance ministry official said.

 

While FPIs can still distort yields on securities outside the fully accessible route, anomalies in pricing of benchmark papers are more prone to spilling over to other bonds of comparable maturities.

 

The timing of the latest change in FPI investment norms can perhaps be explained by the fact that the announcement had to precede the issuance of the new 30-year paper that the government was set to auction this week. As per norms, once a security is designated as fully accessible, it cannot lose the tag. Consequently, the 30-year segment would have been fully accessible by FPIs for at least another year, as long as the new paper was on the run.

 

NEEDLESS TINKERING

Cutting back on fresh additions to the fully accessible route is inconsequential in terms of impact, but unsavoury in terms of messaging. After a much-considered call to fully open up the longer maturity segments of India’s government bond market to FPIs, going back on the decision signals policy uncertainty.

 

The needless flip-flop has left offshore players wondering about the intentions of Indian authorities who in all likelihood, were merely looking to show their hand. Finance ministry officials have said that they have no plans to impose similar restrictions in other tenors, but emphasised that this is certainly an instrument they have at their disposal.

 

If the intent was to keep FPIs away from the 14- and 30-year segments, the government could have simply not issued benchmark papers of these maturities. In fact, it had already initiated this step in April when it decided to issue a 15-year benchmark instead of a 14-year paper in Apr-Sep.

 

Instead, the RBI and the government have opted for an amendment of the rule itself, showing a lack of confidence and just the kind of interventionism that global investors fear from emerging markets. It is certainly not becoming of India, with its strong macroeconomic fundamentals and aspirations of becoming a developed market.  End

 

End

 

US$1 = 83.75 rupees

 

IST, or Indian Standard Time, is five-and-a-half hours ahead of GMT

 

Edited by Vandana Hingorani

 

 

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