Rule change to spur modest rise in infra bond inflows

Rule change to spur modest rise in infra bond inflows

Mumbai: Foreign investment into the country’s infrastructure debt will see a marginal pick-up from the government’s latest efforts to encourage them, although impediments including taxes and a lack of short-term securities remain deterrents, market players said.

In a move to stimulate what have been anemic foreign flows into infrastructure bonds, the government recently reduced the lock-up period on such holdings to one year from three years for a five-year bond for overseas institutions investing up to $5 billion in infrastructure bonds.

That comes on top of a move earlier this year to lift the limit on foreign holdings of corporate infrastructure bonds to $25 billion from $5 billion, in a bid to draw more investment into much-needed roads, bridges and power plants.

This year through August, however, just $109 million of foreign funds had trickled into corporate infrastructure bonds, out of total issuance of $8.6 billion, according to bankers.

India wants infrastructure investment of $1 trillion over five years starting in April 2012 as it aims to boost economic growth to 10% and raise living standards. The country’s infrastructure ranks 89th out of 133 nations, according to a World Economic Forum report.

Industry insiders said the new rule that shortens the lock-in period for holdings is a start, but more needs to be done to accelerate investment in infrastructure bonds.

“FIIs (foreign institutional investors) will be more comfortable with one-year lock-in than three years," said Zafar Islam, head of financing and rates sales at Deutsche Bank in India.

“However, the key issues, such as withholding tax, are still unresolved and this needs to be addressed to really provide a boost to FII participation in infrastructure space," he said.

Foreign investors pay withholding tax of as much as 20%, depending on the tax treaty India holds with the corresponding country. A similar tax is applicable in many countries, including Indonesia and South Korea.

Overseas investors said they find it tough to meet targeted returns after withholding tax, given the credit profile of issuers in India.

Held Back By Tax, Rating

The country’s international sovereign credit rating of BBB-, nine notches below the top level, also deters foreign investors. Debt issued by a firm that is highly rated locally is effectively rated BBB- for global buyers, who thus demand a higher return.

An investment in a 10-year government bond in Brazil, which is rated one notch above India, could yield 12% in Brazilian real to a foreign investor as no withholding tax is applicable, while a bond in India of a similar tenure will draw 20% withholding tax and yield 6.75%.

“With a rating of BBB-, India remains on the brink of investment grade. There are countries like Australia and South Africa which deliver a better risk adjusted return on their local currency debt," Praveen Jagwani, chief executive, UTI International (Singapore) Private Limited, said.

A thin secondary market in shorter-tenor Indian corporate debt also deters investment by foreign funds. Most existing corporate infrastructure bonds are held by long-term investors like pension funds and insurance companies.

“There is only a handful of such securities which has a residual maturity of one to five years," said Singapore-based Ruchit Puri, chief executive at Kotak Mahindra (UK) Ltd.

Still, investors said the new rule is an improvement and they will look to lift their holdings of corporate infrastructure debt.

“We will likely increase our exposure to the market subject to these proposed changes in regulations being implemented," said Kenneth Akintewe, Singapore-based portfolio manager at Aberdeen Asset Management, who handles $7 billion Asia Pacific debt fund and holds government and corporate Indian bonds.

Final notification by the capital market regulator on the proposal is due to be released by 15 October.

“The deterrent to inflows in the infra corporate bonds was the lock-in of three years. If the proposed changes are made, we should expect the demand to increase for such securities," said Kotak Mahindra’s Puri.