MUMBAI: A weakening rupee and higher hedging costs are prompting foreign institutional investors (FIIs) to pare their positions in the Indian debt market. That apart, some investors are apprehensive of how the General Anti-Avoidance Rules (GAAR) would impact their exposures. GAAR, which is part of the proposed direct taxes code (DTC), is expected to come into effect in 2012-13.
Says Birla Sunlife AMC CEO A Balasubramanian: “Some of the money that came in a year back is due for renewal but in the meantime, forward premiums have shot up. While last year at this time they were about 4.5-5%, currently they are at almost 6.5%-7% for one year. For FIIs to want to invest here, the arbitrage needs to be at least 200-300 basis points; otherwise they wouldn’t be interested”.
That’s why despite yields being relatively high — the yield on the 10–year benchmark is hovering around 8.6% — FIIs turned net sellers in March after having been net buyers for five consecutive months between October 2011 and February 2012. Indeed in December, January and February they had bought close to $10 billion worth of bonds after the government eased quotas and allowed them to hold paper of shorter maturities. The auctions were oversubscribed several times with investors paying up to 150 basis points simply to have the right to buy the paper.
However, now that their investments could be taxed, they are likely to think twice. Says Hitendra Dave, managing director and head, global markets, HSBC India: “GAAR could definitely have an impact on debt flows. Some of the selling seen ahead of March-end could be attributed to portfolio re-balancing for the new year when GAAR will be implemented.”
In a bid to attract dollar inflows, the government has been encouraging FIIs to invest in bond markets.
Last November, the limits were opened up by $10 billion, the ceiling for investments in gilts was upped to $15 billion and for corporate bonds to $20 billion. This apart, FIIs can invest $22 billion in infrastructure bonds of which $17 billion is reserved for long-term bonds while the quota of $5 billion attracts a lock-in of one year.
Although yields on both government and corporate paper remain attractive, FIIs prefer to fully hedge their investments and would not expose themselves to the weakening currency. Given the depreciating rupee, FIIs would hesitate to invest in bonds, say market watchers.
Rajiv Malik, chief economist, CLSA recently observed that the rupee remained one of the riskiest currencies and pointed out that capital inflows may not be adequate to eliminate concerns about the smooth financing of the current account deficit. Malik believes that a current account deficit forecast of 3.9% of GDP in 2012-13, together with expectations of a stronger dollar, sets the stage for the rupee to weaken. “We maintain our end-2012 forecast of Rs 55 to the dollar,” he wrote.
After strengthening in January and turning out to be among the best-performing currencies in the region, the rupee has been weakening against the greenback since early February. In March, the rupee lost 3.6% against the dollar. One reason for this has been the smaller portfolio flows into the equity markets in March when FIIs bought just $1.5 billion worth of equities after buying $5 billion worth of stocks in February.
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