FPIs may take up issue of including India in bond indices club with RBI

It will enable them to become prominent investors in govt securities and corporate bonds

Foreign portfolio investors (FPIs) are likely to take up the issue of including India in the global bond indices club during its meeting with the Reserve Bank of India (RBI) next week. Inclusion in these indices, created by index providers such as JP Morgan, could potentially result in billions of dollars in FPI inflows.

It would also enable them to become more prominent investors in government securities (g-secs) and the corporate bond market. 

India had first started talks with global index providers in 2013 but abandoned plans to be included in their indices a year later over differences in removing restrictions on capital flows into the bond market. In 2013, the currency was relatively weak and the country was on the brink of a ratings downgrade, which had prompted the government to think about easing limits in the bond market.

While there is no threat of a ratings downgrade, the currency has come under pressure. A volatile currency, along with the surge in interest rates in the US, has made the Indian debt market less attractive for FPIs. 

The rupee depreciated 8.4 per cent to 69.77 against the dollar in 2018, and has shed 1.7 per cent this year. FPIs sold Rs 46,500 crore worth of debt papers in 2018. 

When interest rates were near-zero in the US, it made sense to come to India, take forex risk and invest in Indian bonds, according to experts. 

One could get a 3-4 per cent return, after hedging. But with the Fed hiking rates and emerging markets now seen as a risky proposition, India has become much less attractive for foreign investors. Volatility in crude oil prices could put the Indian currency under pressure again, and now may be a good time to do away with some restrictions in the Indian fixed income space, they said.

“Inclusion in global bond indices will positively impact inflows. It will ensure that allocations are made to India as funds tracking the index will have to necessarily buy Indian bonds to meet their index tracking obligations,” said Suresh Swamy, partner at PwC India.

The primary condition for inclusion in global bond indices is the absence of restrictions on investments and redemptions. While there are no curbs on selling or lock-in periods at present, there are investment limits linked to the outstanding bond issuances, and certain portfolio level restrictions. 

In April, the government introduced portfolio-level restrictions for FPI flow, capping investment in a single corporate bond to not more than 50 per cent of the bond issue and restricting exposure in any single corporate group to less than 20 per cent of their corporate bond portfolio. 

“With the US tightening likely to slow down, Indian bonds offer excellent investment opportunity for offshore investors and flows must be attracted by easing some of the restrictions. This can prompt addition to global indices which will be a big boost for debt inflows,” said Ajay Manglunia, head — fixed income, Edelweiss Capital.

The regulators have already relaxed the erstwhile hard limits, and the investment now is a certain percentage of the outstanding of government securities as well as corporate bonds. 

Earlier, FPIs could not invest in less than three-year maturity papers. Now, they are allowed to do so provided their total investment in papers maturing within one year does not exceed 20 per cent of their portfolio.

“Increase in demand from an investor class could help in bringing down the borrowing cost of the government and have a positive impact on interest rates in general. It could also help in improving liquidity and volumes in the bond market,” said Manglunia.

Experts, however, caution that foreign money in the debt market can be volatile during times of global turmoil, and wild swings can adversely impact the rupee and bond yields.