FPIs shun Indian corporate bonds

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Mumbai: Foreign investor holdings in Indian corporate debt have fallen since the start of the year, as investors are unwilling to invest in longer-term debt securities issued by domestic firms.

A rule change in February 2015 mandated foreign portfolio investors (FPI) to buy corporate bonds with a minimum maturity of three years.

But as shorter-term securities have matured, foreign investors have not replaced them with longer-term bonds due to concerns about the Indian corporate quality and the prevailing negative sentiment towards emerging market debt. This has meant that foreign holdings of Indian corporate paper have dropped by Rs.12,281 crore so far in calendar 2016, according to data from the National Securities Depository Ltd.

Only 68% of the overall corporate debt limit open to foreign investors has been taken up. At the end of December 2015, 73% of the limit had been utilized.

“Earlier, lots of foreign investors used to buy one-year bonds, hedge the currency risk, and lock-in the spread. Most of these bonds are getting matured now. These are not getting rolled over because of the change in guidelines which put a restriction on the minimum tenure FPIs are allowed to buy,” said a debt market banker requesting anonymity as he is not authorized to speak to the media.

A big chunk of short-term bonds with an average maturity of 18 months bought by FPIs in 2015 matured during the first two months of 2016.

Normally, the FPIs would have rolled these investments over by investing the maturity proceeds in fresh corporate debt. But as the credit ratings of many leveraged corporates are being downgraded, FPIs do not want to take a long-term call by buying bonds of above-three-year tenure.

Credit quality of companies in power, roads, real estate, metals and mining, and capital goods sectors have deteriorated in fiscal 2016 owing to a global meltdown in prices, high debt levels and reducing profitability, Crisil Ratings had said in an 11 March report.

Crisil expects the ratings of such firms to remain under pressure in fiscal 2017 as well.

Besides this, there is a general risk-off sentiment towards emerging-market debt. These concerns stem from the increase in corporate indebtedness in emerging economies and higher interest rates in the US, following the Federal Reserve’s decision to hike rates in December last year.

This has slowed the inflows into government debt as well. Government bond holdings have risen by a relatively small Rs.1,730 crore in 2016 so far. Including government and corporate debt, FPIs liquidated an aggregate Rs.8,806 crore worth of bonds between 1 January and 15 March from secondary market, shows provisional data from Securities and Exchange Board of India that captures FPI debt transactions in the secondary market.

“Debt flows in India have been muted for the last two months. It is not a reflection on Indian markets in particular, and we have been quite insulated from the outflows from emerging markets. It is more to do with the allocations that international investors make during the beginning of the year. There have been large outflows from emerging markets since the beginning of 2016; though there have been outflows from India too, it has not been material,” said Manish Wadhawan, managing director and head of interest rates, HSBC India.

But some are hopeful inflows would soon resume, given that Indian bonds still give one of the highest returns among emerging markets, and the debt market would benefit from a fiscally prudent government and an easing monetary policy cycle.

“My sense is outflows will slow and, given that inflation is stable, the budget was friendly, further monetary-easing expectations have built up and yields are attractive, I would expect inflow trend to come back. I would not extrapolate what we have seen in February to the rest of the year,” said Vivek Rajpal, interest rates strategist and executive director at Nomura Holdings Inc. in Singapore.

Rajpal expects inflows to pick up although they may not match that of the previous years. In calendar 2014, FPIs had poured in $26.25 billion into bonds but in 2015 debt inflows added up to only $7.56 billion.

With an aim to attract more stable dollar flows into domestic bonds, on 3 February 2015, the Reserve Bank of India had said that FPIs cannot buy corporate bonds that have less than three years tenure. For investments in government bonds, this rule was brought much earlier in July 2014.

FPI purchases of Indian bonds have typically been short-term and not for the purpose of holding them until maturity. RBI has termed such flows as hot money and has sought to quell this by restricting investments in papers with maturity of less than three years.