Hopes rise over Indian bond investment cap

Managers are hopeful that India's new finance minister will lift the cap on foreign investment in domestic government bonds, which were over-subscribed in an auction this month.
Hopes rise over Indian bond investment cap

Fund managers have expressed hope that India’s new administration will raise foreign investor limits on government bonds in today’s budget, which they argue have choked demand.

All eyes will today be on new finance minister Arun Jaitley, as he presents his maiden national budget for the fiscal year ending next March.

While prime minister Narendra Modi’s stated priorities including reviving stalled investment projects, spurring growth, containing fiscal deficits and tackling inflation risks, foreign investors feel that relaxing restrictions on fixed income investment would be just as pertinent.

They said Indian government bonds, in particular, are under-owned and hope Jaitley will raise the $30 billion aggregate fixed income asset cap now imposed on foreign investors.

Foreign institutional investors (FIIs) can own a total of $20 billion of Indian debt, while up to another $10 billion can be bought by ‘longer-term asset owners’ – namely sovereign wealth funds, multilateral agencies, insurance funds, central banks, pension funds and endowment funds.  

As of July, 99% of the $20 billion investment limit for FIIs – now technically known as 'foreign portfolio investors' in India – had been used, but only 20% of the extra $10 billion has been utilised, according to India’s National Securities Depository.

Foreign investors own 35% of Indonesian and 45% of Malaysian government bonds, but just 2% of Indian government bonds, noted Desmond Soon, Singapore-based co-head of investment management for Asia ex-Japan at Western Asset. “There is a lot of headroom to attract real money from investors looking for a good growth story and bond yields.”

Praveen Jagwani, Singapore-based chief executive of UTI International (the offshore arm of UTI Mutual Fund), echoed this point. Interest in India fixed income has been a lot higher this year than last due to rupee volatility in 2013, he noted, with foreign investment almost hitting the cap following Modi’s being sworn into office in May.

Last month the government restarted its bond auction process, a mechanism that kicks in once the overall investment by FIIs reaches 90% of the overall limit. This month, bonds worth $918 million were sold to foreigner investors against bids totalling $1.13 billion. The previous auction was held in August last year.

In the first five months of this year, foreign institutional investors bought Rp461.2 billion ($7.7 billion) of Indian debt and Rp458 billion of equities. In the same period last year, total foreign investment was Rp1.07 trillion, with debt attracting just over half of the amount so far this year.

As money managers are attracted to the 8-9% yields on Indian rupee government bonds, said Soon, raising the investment limit would encourage more inflows from medium- and long-term investors. Ten-year government bonds are trading at 8.5% yields.

Meanwhile, both Soon and Jagwani feel that interest rates are not likely to fall any time soon.

“Due to persistent inflationary pressure, the market is not expecting the central bank to cut the interest rate any time soon,” said Jagwani. This is likely to support bond demand as against interest in equities, he noted.

Soon agreed that there is limited room for the Reserve Bank of India to cut the interest rate in the near term. As a result, the risk-adjusted return for longer-dated bonds is less attractive than for shorter-tenor (three- or five-year) government bonds, he said.

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