On Friday, policymakers unveiled a wide-ranging set of measures to draw in overseas capital while shoring up the currency and external balances, which have been strained by higher oil prices.
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They scrapped withholding and capital gains taxes on foreign investments in government bonds, broadened the pool of securities that are available without investment limits and introduced incentives to encourage banks to raise foreign currency deposits from non-resident Indians and for companies to tap overseas borrowings.
The slew of measures, rolled out in response to the oil shock that has hit Indian assets, is beginning to lure foreign investors back into an overlooked market against a backdrop of rising global rate volatility.
“We believe that these changes are a game-changer for debt flows,” said Jennifer Taylor, the head of emerging market debt and systematic fixed income at State Street Investment Management, which manages about $5.6 trillion in assets.
The pace of foreign inflows has quickened since the measures were introduced, with more than $1 billion worth of government debt bought in just three sessions. Before the announcement in the year-to-date period, $1.6 billion had been purchased.Yields on government bonds have fallen 10 to 30 basis points across the curve, with shorter maturities seeing the biggest declines.
The removal of taxes makes Indian government bonds more attractive on a relative basis, Taylor said, adding that the measures should boost foreign participation across the yield curve and lower borrowing costs over time.
Some investors said the reforms could prove more consequential over the longer term by paving the way for India’s inclusion in broader global debt benchmarks, which would bring more durable and predictable inflows.
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Niel Clement, portfolio manager for emerging market fixed income at BNP Paribas Asset Management, which manages more than €1.6 trillion ($1.85 trillion) of assets, said the steps would broaden opportunities for overseas investors, redirect flows to the onshore market and provide a constructive boost to India’s bid for inclusion in the Bloomberg Global Aggregate Index.
Bloomberg Index Services is expected to seek investor feedback later this month on whether Indian government bonds should be added to its flagship global bond index.
M&G Investments, which manages about £376 billion ($503.4 billion) of assets, said the tax exemptions have boosted the near-term appeal of Indian government securities.
It added that inclusion in the Bloomberg index would be a bigger driver of inflows, similar to India’s entry into JPMorgan’s emerging market debt index.
In the weeks before the tax cuts were rolled out, India’s finance minister met with officials at the central bank to push for entry into the Bloomberg index, a government official said on Tuesday.
“We view the measures announced aimed at addressing pressures on the capital account as having effectively restored policy control,” said Low Guan Yi, head of Asia fixed income at M&G Investments.
“With steps taken to support macroeconomic stability, we see investment opportunities as India continues to differentiate itself from other emerging bond markets with more limited policy flexibility.”
UBS Asset Management, which is neutral to underweight on Indian fixed income, said the Reserve Bank of India’s moves signaled a constructive approach toward broadening market access and they will encourage more foreign inflows over time.
“India is an important part of EM local index so we are always reviewing it as an investment option,” said Shamaila Khan, head of fixed income emerging markets and Asia-Pacific at UBS Asset Management.
CURRENCY, ENERGY RISKS
Investors cautioned that while the measures improved the appeal of Indian debt, the outlook for foreign inflows will remain closely tied to the rupee’s trajectory.
“The bigger issue for offshore investors is still the currency,” said Rong Ren Goh, head of macro and thematics for Asian fixed income at Eastspring Investments, which manages about $250 billion, adding that investors are likely to wait for clearer signs of rupee stability before raising allocations.
The recent pace of rupee depreciation has dented the carry appeal of Indian debt, while higher energy prices have added to the pressure, he said.
The rupee is down 5.86% so far this year, trailing only the Indonesian rupiah as Asia’s worst-performing currency, though it has experienced modest relief since the bond tax moves; it was last at 95.16 per dollar.
Economists at Citi sharply revised India’s balance of payments forecast for the current fiscal year, a shift they say should underpin the rupee. They now expect a $5 billion surplus versus an earlier projected deficit of $60 billion.
Other investors warned that the broader backdrop for bonds remained challenging amid high global interest-rate volatility and inflationary pressures stemming from energy prices.
“The broader investment backdrop for bonds remains challenging, given the pickup in interest-rate volatility across many markets and the shift from monetary easing to tightening in response to inflationary pressures from energy and food prices,” M&G Investments’ Low said.