We can use the money but witholding tax should go, say bankers.
India’s government and corporate sector debt is likely to attract more foreign funds after the government increased the ceiling on such investments, say bankers. However, India still needs to resolve issues like withholding tax before it can see the trickle turn into a regular flow, they say.
Low yields from similar investments in the US and rising appetite for funds in India are among the immediate factors that could attract overseas funds. The rupee today gained 34 paise to 45.26 per dollar as this factor added to the sentiment, dealers said.
The government yesterday permitted global funds to invest an additional $5 billion
(Rs 22,800 crore) in bonds issued by companies in the infrastructure sector. It also increased the investment in government bonds by an equal amount, raising the overall limits to
$20 billion (Rs 92,000 crore) for government bonds and $10 billion for corporate bonds.
A 10-year Indian government bond offers a yield of 7.87 per cent, compared with the 2.54 per cent yield on a similar maturity bond in the US. The bonds of AAA-rated companies maturing in five years in India could offer up to 8.6 per cent, said bankers.
Increasing foreign inflows are also likely to improve liquidity for government bonds, helping yields to fall once inflation decelerates. Today, the yield on 7.8 per cent bonds maturing 2020 fell three basis points to 7.87 per cent, following a four-basis-point decline yesterday.
“With the US Fed appearing to be moving closer to a second round of quantitative easing and with US yields likely to remain lower for a longer period, we expect real money investors to buy into these increased limits,’’ Kumar Rachapudi and Rahul Bajoria of Barclays Capital said in a note from Singapore. “With the current FII limit of $5 billion in government bonds exhausted and about 85 per cent of the $15-billion limit in the corporate bond market already taken up, we think this increase in limits will attract foreign investors.”
India aims to spend $1 trillion (Rs 46 lakh crore) in five years to March 2017 on infrastructure, about double its current spending. The government is keen to ensure there is no shortage of funds. Several banks had given loans up to their full sectoral limit to the power sector and overseas funds could help, said a banker.
Low yields in the past few years have turned global investors to Indian debt for its returns and safety. The investment in bonds by foreign investors has risen $9.75 billion since January 1.
For India, these investments, with a condition that they be made in bonds with at least five years’ residual maturity, will be particularly welcome since they will bring long-term investors like pension funds, which will not enter and exit frequently so as to make such inflows volatile, a major concern for the central bank. The Reserve Bank of India has supported overseas funds that can supplement domestic efforts to finance infrastructure projects, but it emphasises on preventing volatility.
“We think the condition that the incremental investments be made only in securities with a residual maturity of five years and above will now attract a different set of investors,’’ Rachapudi and Bajoria said in their note. Still, the government imposes a withholding tax of about 20 per cent, payable at the maturity of bonds. This reduces their attraction, while encouraging investors to go for shorter maturity debt to avoid tax, bankers say. This also increases volatility of flows.
“The withholding tax should be eliminated, especially since the current limit is being raised for a specific segment and a defined maturity,” said Prawin Devchell, managing director and head of debt capital market for syndications and structured finance at IDFC Ltd. “One could see the size of inflows rising significantly if the tax is reduced or removed.”
Most investors in corporate bonds go for one year to two year bonds, with a preference for zero-coupon types, according to some bankers.
Purchase of bonds by overseas investors also has the potential to stabilise the local currency and prevent any sharp appreciation or depreciation, while helping narrow the current account deficit. Sterilization of inflows by the Reserve Bank of India would improve local liquidity too.
