Channel: Corp Finance
India has increased the cap of FII flow to debt market. The message is loud and clear. India is now more assertive towards bridging the demand supply gap in the financial market. The current decision not only provides India the opportunity to access a large pool of capital from worldwide but also a golden opportunity to Foreign Institutional investor to tap the high yielding bond market of Asia’s third largest economy.
The increase in the limit of FII investment in Government Securities from US$5bn to US$10 billion and corporate bond to US $ 20 billion from the existing $ 15 billion is a positive step towards providing greater linkage to the international interest rates. The incremental limit of US $ 5 billion will be invested in securities with residual maturity of over five years. For corporate bonds the maturity remains same but with the rider that bond should be issued by companies in infrastructure sector.
The enhancement of the Fll investment cap would provide avenues for increased Fll investments in debt securities, help investment in infrastructure sector and the development of Government securities and corporate bond markets in the country.
The policy review is a significant development in the context of lndia's evolving macroeconomic situation, its increasing attractiveness as an investment destination and need for additional financial resources for lndia's infrastructure sector while balancing its monetary policy.
The higher cap for corporate bond is easy justifiable looking at the quantum of requirement as well investor’s preference for them. Given the large spate of issues in recent times, a stronger rupee and the 200-basis point differential over the government bond, FIIs, who are more tuned into short-term investments, find it more feasible to invest in corporate bonds rather than those issued by the government.
FIIs, usually, invest in debt when they spot an arbitrage opportunity. This allows them to borrow overseas at around Libor and invest locally and earn a spread after hedging against foreign currency risk. Indian Economy growing with more than 8% clearly provides the opportunity for the arbitrage and so more FII inflow cannot be ruled. What India needs is its ability to absorb the glut of fund. Moreover the fund inflow is not always certain and European (Greece, Ireland, Euro) crisis might also put an impact on it in the coming days. So the best policy is to grab it with full hands whenever there is an opportunity.
A look at the table suggests that appetite for the debt in Indian market has been huge. The FII limit for Government security was $ 2 Billion in 2006 and has been raised to $ 10 Billion in 2010.The total cap for FII inflow in debt was $ 3.5 in 2006 and in 5 years this has become 9 fold to reach the magic figure of $ 30 billion. Looking at the need of $ 1 Trillion for infrastructure, India needs to have access to bond market and so increased limit are in sync with the requirement.
The silver lining for the debt market is that after financial crisis the investors are more inclined to park their surplus in the debt market. So the endeavor should be to tap the opportunity to access to capital from FIIs willing to invest in India. Also, the increase in limit is very well justified as debt market in India has been able to get investment even in 2008 when the net FII equity inflow was negative. During the financial crisis the current account deficit has become irrelevant and so it’s time to rectify the huge deficit.
The only caution for the government is that it should ensure that there is no crowding out effect. This may lead to serious problems for India Inc and can dampen its growth prospects.
Though the broad dynamics of FII inflow for debt market will depend on external as well as internal factors, the increase in limit is a welcome step. As India moves towards a more efficient financial market structure the FII can provide the much needed impulse to the debt segment.
© Copyright ETI Dynamics Ltd. 2011.