Seek long-term capital

Foreign portfolio investment, or FPI, continues to pour into India. So far, the month of July has seen an inflow of about $2.4 billion, taking the total for the year up to approximately $25 billion. Much of this came in a great surge in March, perhaps after the Bharatiya Janata Party’s victory in the Uttar Pradesh assembly elections raised expectations of a revived reform agenda. So far in July, the vast majority of the funds have flowed into debt. In fact, it could be argued that the authorities have aided the flow of foreign portfolio investment into Indian debt; the market regulator, the Securities and Exchange Board of India (Sebi), earlier this month, marginally raised the FPI investment limit in central government securities (G-Secs) to just under Rs 1.88 lakh crore from Rs 1.85 lakh crore. The limits for FPI in state development loans were also revised. This followed a decision by the Reserve Bank of India (RBI) to change these limits for the July-September quarter. The RBI increased the investment limits for FPIs in G-Secs by Rs 11,000 crore to Rs 2.42 lakh crore. More startlingly, the FPI limits for state development loans were increased by 22.5 per cent, or Rs 6,100 crore.

Is India developing a dangerous overdependence on robust foreign flows? FPI flows, which depend on expectations of robust reform, may reverse swiftly as and when those hopes are dashed. And it is not as if domestic conditions are the only criterion; as the RBI’s Monetary Policy Committee pointed out in April, there were net outflows in FPI between November 2016 and January 2017, thanks to “turbulence in global financial markets” that “set off a bout of global risk aversion and [a] flight to safe haven[s]… The tide reversed with the pricing in of the Federal Reserve’s normalisation path and improvement in global growth prospects”. The RBI MPC also pointed out that the FPI surge in March was focused especially on debt markets as opposed to equity markets; the former had been the dominant recipient until February. Another unfortunate effect has been to keep the rupee artificially high, which renders India’s exports even more uncompetitive.

Some moves by the authorities would indicate that concerns are developing about a dependence on FPI debt in particular. Last week, Sebi said that rupee-denominated bonds in the foreign market (“masala” bonds) would no longer be issued until FPIs’ utilisation of their total quota of corporate debt (Rs 2.44 lakh crore) fell below 92 per cent. The market regulator should have started auctioning the remaining limits when FPI possession of corporate debt went above 90 per cent, but it seems to have let that slide a little. And the RBI has tried to tweak the FPI quotas to ensure more debt is bought by long-term, “patient” capital such as pension funds. Only a fifth of G-Secs in FPI hands are held by long-term investors. Earlier this month, citing macro-prudential management, the RBI indicated that future increases in the limit for FPI investment in state and central government debt would be allocated in a three-to-one ratio in favour of long-term investors. This bias towards long-term funds should be enhanced; secure guarantees for hot money should be minimised, so the macro-economic effects of dependence do not pose a structural danger to the economy.