Mumbai: A working group appointed by the Reserve Bank of India (RBI) has suggested that the limit on foreign institutional investment (FII) in government securities should be increased once a year.
It also suggested ways to make the market for government bonds more liquid.
“The increase in the investment limit can be reviewed on a yearly basis keeping in view the country’s overall external debt position, current account deficit, size of GoI (government of India) borrowing programme, etc.,” the panel headed by RBI executive director R. Gandhi said.
Currently, foreign institutional investors (FIIs) can invest up to $15 billion (around Rs 84,600 crore) in government securities, a figure that has been gradually raised as India eases restrictions on investment in local debt as part of a wider attempt to pull more capital into the country.
In an article published in The Indian Express newspaper on Thursday, J.P. Morgan Chase and Co. India chief economist Jahangir Aziz suggested that India should raise the FII limit on government securities to $50 billion, “with no strings attached”.
The report also called for a “comprehensive review” of the withholding tax, a sore point for foreign bondholders. A withholding tax of 20% is paid by the investor at the time of receiving the annual coupon payment on the bond. FIIs have argued that post-tax returns shrivel after paying for hedging cost of their money.
Among its other recommendations, the panel has also suggested a review of the current cumbersome bidding process that FIIs have to go through when they buy local bonds.
The panel is also of the view that banks should be given the leeway to review their so-called held-to-maturity (HTM) portfolio once in a quarter against the present practice of reviewing it once a year. Once a bond is put into HTM, the bond cannot be traded in the market.
The Indian central bank should come up with a road map to gradually bring down the upper limit on the HTM portfolio, it said. To encourage more retail buying of government bonds, the panel has recommended that bank branches and, at a later stage, post offices be used as a distribution channel.
“FIIs are hesitant in utilizing their limits in bonds maturing in more than five years because they get forward cover (in foreign exchange) of only one year and then they have to roll it over. They prefer to participate in shorter maturity paper and their limits for bond over five years typically remain underutilized. So to increase their participation, government may have to tweak the norms so that they can invest in any securities with flexible lock-in period,” said Prasanna Patankar, senior dealer at STCI Primary Dealer Ltd.
Comments on the draft report could be given to RBI by 22 June.