FII investments in debt: Why are we lower down in pecking order?

Foreign institutional investment or foreign portfolio investment in debt is subject to limits in India. While limits are justified from the perspective of controlling hot money as any bunching of outflows may create stability issues in currency and debt markets, there is scope for a debate on the utilisation levels.

Foreign investments, subject to limits, are welcome as they create that much demand for the fresh supply of instruments. Currently, the limits are 6 per cent of outstanding stock for government securities, 2 per cent for state development loans (SDLs) and 15 per cent for corporate debt. For a utilisation perspective, for government securities in the general category of FIIs (there is another long-term category), the limit available for utilisation in FY2020-21 is Rs 2.35 lakh crore. Of this, utilization as of July 17, 2020, stood at Rs 0.96 lakh crore i.e. 41% of total limit. In the long-term category of government securities for FIIs, out of the Rs 1.04 lakh crore limit, Rs 0.26 lakh crore i.e. 25% has been utilised. Next in the hierarchy of securities, SDLs have seen utilization is only Rs 700 crore out of the Rs 64,400 crore limit i.e. approximately 1% for general category. In the long-term category of SDL, the entire available limit of Rs. 7,100 crore remains unutilised. In corporate debt, of the Rs 4.3 lakh crore limit, the utilisation has been Rs. 1.56 lakh crore i.e. 36 per cent of total limits.

What works for us? A combination of attractive yield levels and decent fundamentals? Only a handful of countries in the entire world offer a similar yield with good fundamentals. The yield on our 10-year government security is 5.8 per cent. For a comparison, Brazil’ 10-year G-Sec yield is 6.5 per cent, but their sovereign rating is BB- by S&P, below investment grade and below India’s rating. Similarly, South Africa has a higher 10-year yield of 9.4 per cent, however the sovereign rating is BB- by S&P. Russia has a comparable 10-year yield of 5.86 per cent and same rating as India’s. Only Indonesia has a better 10-year yield of 7 per cent odd and a sovereign rating one notch above India’s. China has a higher credit rating than India, but the 10-year government bond yield is 3 per cent odd.

What ails this space?
Broadly three factors.

One, sovereign rating. We are investment grade, but just investment grade. Till sometime earlier, Moody’s had a rating of one notch above investment grade, but now it has brought us down to Baa3. S&P rates us at BBB- and so does Fitch. For the given rating, there is the ‘outlook’ which broadly indicates the opinion on the likely direction of movement of the rating in the medium term. Only S&P has a ‘stable’ outlook for the BBB- rating, whereas Moody’s (Baa3) and Fitch (BBB-) both have ‘negative’ outlook.

Two, global bond indices. Many foreign institutional investors take the weightage in global indices as a proxy or reference point. Since we are not yet part of such indices like JPMorgan Emerging Market Bond Index or Bloomberg Barclays Emerging Market Bond index, we are missing out on allocations.

Three, perception and home country bias, mostly the US. In the absence of inclusion in the global bond indices, we being an emerging economy, safety is perceived in the home country/developed economies. In March 2020, which was the initial phase of the lockdown and consequent uncertainty, FIIs sold Rs 60,000 crore ($8 billion) of debt investments in India. The same continued in April to June as well, albeit at a much slower pace resulting in a cumulative sale of Rs 37,000 crore ($5 billion). However, in July net purchase of debt by FIIs stood around Rs 2 billion till July 17, 2020.

What is required?
Marketing ourselves. In the context of sovereign rating, we have (a) a buoyant GDP growth rate (please forget the Covid-induced slowdown, it has impacted the entire globe), better than most of the countries with a similar rating of BBB- (b) our current account deficit (CAD) is now turning into a mild surplus as imports continue to plunge and (c) our government budget deficit is funded through internal borrowings i.e. domestic savings take care of it.

We need to present ourselves to the rating agencies in terms of our inherent strengths. Even Italy has a credit rating one notch higher than India’s. While they have the ‘backstop’ of the European Union, we know the challenges to their debt servicing.

By virtue of the EU backstop, Italy has a 10-year G-Sec yield of 1.2 per cent and even Greece, which is below investment grade, has a similar bond yield!

Efforts have been made for inclusion of India in the global bond indices by various regimes at the centre, only that it has to be given the final push and brought to the logical conclusion.

While issuance of government bonds abroad is one of the ways, it has its pitfalls. It can be managed in a smarter way by allowing unlimited investment by foreigners in certain domestic issuances of government bonds, while taking care of the overall ceiling.

Lastly, operational processes for investments by foreigners need to be simplified further, so as to give them a seamless experience.