Budget 2018: Dhawal Dalal of Edelweiss AMC seeks increase in FII limits for bonds


We expect the government to announce an increase in the FII limits for bonds in Budget 2018 because we are currently capped at 5 percent, Dhawal Dalal, CIO-Fixed Income, Edelweiss Asset Management Company (AMC), said in an exclusive interview with Moneycontrol’s Kshitij Anand.

Q) What are your expectations from the upcoming Budget from Bond market perspective?

A) From the bond markets perspective, I think the Finance Minister has been very clear the government would like to maintain the fiscal consolidation path. Bond market participants do expect the glide path to alter.

For example, this year the fiscal deficit is expected to be closer to 3.2 percent and for the next year, the target is 3 percent based on the FRBM trajectory. I think there could be some change in that.

Dhawal Dalal
Dhawal Dalal
CIO-Fixed Income|Edelweiss Asset Management Company
Expect 10-year bond yields to trend towards 7.39%: Dhawal Dalal
Hawkish tone by MPC may push 10-yr yields above 7.10% mark: Dhawal Dalal
10-year bond yield to remain below 7.10%: Dhawal Dalal
We expect the government to adhere to 3.2 percent in FY18 although there are some market participants who believe that given the shortfall in the revenue there could be a possibility of additional borrowing and that may lead the fiscal deficit to widen.

Some market participants even expect the government to borrow additionally. We, on the other hand, believe based on the information we have from the Finance Minister, the government will make every attempt to adhere to the 3.2 percent fiscal deficit target because for them the credibility of the government in the eye of the investors both local, as well as foreign investors, is paramount.

I think that has also got reflected in the recent upgrade from Moody’s upgrade.

Based on all these parameters and the information, I believe that the government will adhere to the fiscal consolidation path and will not get into any kind of populist measures without any impact on job creation.

The government may do anything which will help them create jobs because that will be a very important parameter going into the next elections.

Q) Coming from the fixed income point of view, if you were the Finance Minister, what would you have done?

A) From a central governments perspective, the measures taken by the government are pretty much in line with what the market had anticipated such as reduction in gross borrowing numbers.

From a fiscal deficit perspective, if you look at the total fiscal deficit, the government has managed to reduce the amount to be borrowed from market borrowing as against an average of about 90-95 percent of the fiscal deficit to be funded from market borrowing.

Last time, the government has borrowed around 80-85 percent. The latest data suggests there has been a reduction on the reliance of funding of fiscal deficit through market borrowing which is a very commendable stance that the government has taken.

Number two, the government has been very clear and unambiguous that any kind of farm loan waivers announced by the states so far, there will be no support from the central government.

So, whether these are BJP-led states or non-BJP led states, I think the government has maintained very clear and unambiguous stance which has sent a very positive signal to market participants.

In August we saw the benchmark 10-year at around 6.40 percent and currently, it is at about 7.05-7.07 percent and part of that is attributed to the weakening of the sentiment because of these selective leaks.

As a Finance Minister, I would perhaps take a look at any kind of news whether confirmed or unconfirmed which can move the market. GST – a lot of market participants do believe that it could have been little more fine-tuned.

These are some of the things but I guess from his perspective I think given the rise in FDI, given the rise in the FII inflows in bond and equities, highlights the confidence of the market participants on the government of India’s fiscal and monetary policies.

Q) FIIs were net sellers in the secondary market but they were big buyers in the primary as well as in the bond markets. So, do you think the sentiment will continue?

A) I think everyone is chasing returns. In terms of the equities market, we have observed that India is perhaps in the middle or lower, in terms of the kind of returns which were generated in 2017. From that perspective, it is natural that investors have allocated less amount of money.

In China, people have allocated more money and there are some other countries that have got a bigger share of FII flows as far as equities are concerned and same goes for bonds also.

This year has been the year where a lot of other countries have generated double-digit kind of return in dollar-denominated returns. Because of the US dollar’s secular decline against some of the G7 currencies as well as some of the Asian peers including India, I think the dollar returns have been pretty decent in the bond market.

As far as India is concerned, I think a lot of foreign investors have appreciated the higher real rates, the relative stability of the currency and the clarity in both the monetary and fiscal policy framework that the government of India has articulated.

All these ingredients have contributed to decent inflows. Going into FY19, we do expect the government of India to announce a further increase in the FII limits for bonds in the Budget because we are currently getting capped at 5 percent.

For a country like India which is capital starved, it is important if we see further participation of the FIIs in government bonds going forward.

We believe that up until the NPA issue gets resolved for banks they will not be willing participants in government bonds going forward.

Q) Any particular number from 5 percent could be tinkered to?

A) I would say maybe between 7 to 8 percent in a gradual manner.

Q) S&P appreciated the efforts done by the government in terms of policy measures, but were you disappointed they did not upgrade the outlook?

A) Our sense is that the foreign rating agencies are paying undue weight on the fiscal deficit numbers, the outstanding debt. If you look at all the countries which are rated BB, BBB and BBB+ and BBB-, some of the economic parameters that stand out for India is the fiscal deficit number and total government debt to GDP ratio.

On the rest of all other parameters, I think we are quite comparable or better as compared to some of the other countries which are smaller countries. From that perspective, I feel that it is a little unfair to put a country like India in the same kind of category as some of the smaller country. Only another large country that I noticed was Spain.

Q) What is your call on the rupee? It has been appreciating.

A) The rupee has been range bound with an appreciating bias and part of the reason is that there are very strong flows coming from both the FDI as well as FII.

The year 2016 and 2017 were the years where the FDI inflows were larger than the FII inflows, particularly for equities. A couple of large deals which have contributed to large inflows was the Essar deal which has gathered between USD 10 billion and USD 13 billion kind of thing and because of the openness of the market.

Going forward, we do expect this trend to continue going into the next financial year as well. The government is quite eager to ensure that the ease of doing business improves further going forward.

The way the NPA resolutions are taking place, we do expect foreign market participants to take a serious look at some of the assets which are available and then try to invest into that.

Our base case is that the FII flows will continue to be healthy in a country like us and that will perhaps keep the rupee range bound with an appreciating bias.

Is it good for the economy? It is good for the inflation, but it may not be good for exports. That said, the relatively rich level of the rupee is also resulting in a lot of non-oil, non-gold import increase, particularly electronic items.

This to a certain extent is affecting the competitiveness of our own industry and then it is not helping the Make in India initiative. It is perhaps adding as a headwind for the Make in India initiative.

Although, Make in India did not start in a big way, I am sure that the government of India is cognizant of the overvalued level of the rupee as compared to some of the basket currencies in a tradable basket.

Last time when I checked, it was 15-16 percent overvalued from a real effective exchange rate perspective. But, so long as it is helping us to keep the inflation in check, it is a decent thing to have because FII flows are very important to have right now.

Q) Any target range that you have for this calendar year or the next?

A) One thing I have understood is that with respect to foreign exchange, it is very difficult to have a range. We have observed in the last 2-3 years that the rupee forwards were forecasting about 6 percent depreciation a year on average.

Now that the range has narrowed to about 3.5-4.5 percent which is in line with the increase in inflation. The actual movement of the rupee has always done better than the forwards and forwards have always exhibited a declining trend primarily because of the interest rate parity and the inflation.

The actual movement of the rupee has always been better. As a result, a lot of market participants are running unhedged positions. Keeping that in mind, any kind of global event has a potential to destabilise.

For example, any adverse outcome in Union Election in 2019 could have a potential to disrupt the foreign exchange market. Although that is not our base case but as you know, it is very difficult to forecast how people think.