A committee of the Reserve Bank of India (RBI) has suggested increasing the foreign institutional investment limit in the government securities (G-secs) market in a gradual way. This is expected to boost primary liquidity in the market.
At present, the investment limit for FIIs in G-secs is capped at $15 billion (Rs 84,000 crore) of which $5 bn is reserved for investment in securities with residual maturities greater than five years.
“FIIs, by being global players, can provide much needed diversity of views in the market, thereby providing more opportunities for trading. Thus, the group is of the view that there is a need to encourage FIIs as an investor class in the G-sec market,” said the committee, set up to suggest ways to enhance secondary market liquidity in this and the interest rate derivatives market.
The panel suggested a gradual increase in the investment limit, to minimise the impact of any sudden exit of investors on capital flow or market volatility. The increase in the limit should be reviewed on a yearly basis, keeping in view the country’s overall external debt position, current account deficit and size of the government borrowing programme, it said.
The draft report of the panel, chaired by executive director R Gandhi, was placed on the RBI website on Thursday for public comments. The last date for this is June 22.
Calling for a comprehensive review on the issue of a withholding tax for FIIs, the panel said this tax has been a major roadblock for FII participation in local currency bond markets, since this reduces the investment yield and complicates accounting and transactions procedures for many, especially real-money investors. Elimination of such a tax will lead to long-term benefits for the financial market by improving market efficiency.
At present FIIs pay a 20 per cent withholding tax on income. If it is scrapped and the overall tax burden also brought down, their interest in gilts will grow, said a partner with a large accounting firm.
According to RBI data, the settlement volume in G-Secs market has shown a secular rising trend since 2005-06 and has more than trebled since then. However, the growth in volume in recent years has not matched that during 2005-10.
Retail participation
Lack of liquidity has been cited as one of the hindrances to retail participation in the fixed income market. “Due to the lack of secondary market liquidity, investors, especially retail/individual investors, end up paying a large illiquidity premium when they try selling the illiquid (off-the-run) securities,” it said.
The committee suggested there was a need to examine using banks and post offices at a later stage as a distribution channel and nodal point for interface with individual investors. Considering uniform charges for opening and maintaining gilt accounts and for putting through each transaction was also suggested.
Sebi norm review
The working group also called for a review of the Securities and Exchange Board of India’s norms that require foreign investors to surrender their limits in debt securities, including gilts on sale or maturity.
On January 3, Sebi withdrew the re-investment period facility for debt limits allocated to foreign institutional investors. Sebi said the debt investment limits allocated to FIIs through bidding would lapse if the investor sold the security or the bonds matured. Foreign investors have to wait for fresh allocation of limits in such an event. They’d pulled out funds from domestic debt securities following the withdrawal of the reinvestment facility. In March and April, foreign investors sold $2.19 bn worth of debt on a net basis.
The panel also called on RBI, in consultation with Sebi, to amend related notifications that restricted FII transactions in gilts through only exchange brokers.
