FIIs in Debt

Why the FIIs are finding Indian debt more attractive…

The recent debt auction received a roaring response from the FIIs. In the last credit policy, the RBI governor had announced that the FII limit in debt will be enhanced by over Rs.1200 billion. This supply is likely to be lapped up very fast. Why is it that FIIs find Indian debt so attractive?

A recent report by CLSA has pointed out that most FIIs currently prefer Indian government debt over equity. This could be partially due to the scarcity factor but it also has to do with the relative attractiveness of debt in India versus equities. Let us understand why…

Scarcity is an issue…

The biggest reason is that there is a scarcity of debt available to FIIs. For long, the FIIs have been close to their outer limit for FII investment in debt. That has left them with little room to increase their exposure. The recent government decision has come as a short in the arm for FIIs, who are trying to lap up as much of debt as possible. The corporate debt is still the second option for most FIIs. This scarcity factor probably explains why FIIs prefer Indian debt at this point of time.

Yields are attractive…

Indian debt has one of the most attractive yields currently. Add to this the fact that the Indian rupee has been largely stable versus the dollar, barring occasional bouts of volatility. This has ensured that FIIs do not see their currency risk washing away their debt returns.

Falling interest rates is another attraction for FIIs. The RBI has already guided towards a benign interest rate regime. With inflation under control, the FIIs are expecting further rate cuts from the RBI. That will mean capital gains on FII bond holdings, which is an added advantage. More so, since FII capital gains on debt tend to get preferential tax treatment in India.

Equities have too many gaps…

To be fair most FIIs are skeptical about investing in equities as there are too many loose ends. GDP growth is likely to be lower than originally anticipated and corporate results are hardly showing any traction. The overhang of US rate hikes hangs over the Indian markets and that cannot be wished away. Even in valuation terms, Indian equities look richly valued, especially when compared to markets like China that have corrected 35% from their peak levels. The equity market punch is clearly missing for the FIIs.

To sum it up, the availability of debt avenues is a big boost for FIIs. More so,  considering that rates are likely to fall and equities are not exactly looking attractive. For India, the dollar flows itself is a reason to celebrate! ©

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