Foreign Portfolio Investors (FPIs) Withdraw from Debt VRR Segment: Reasons and Impact
- January 23, 2024
- Posted by: OptimizeIAS Team
- Category: DPN Topics
Foreign Portfolio Investors (FPIs) Withdraw from Debt VRR Segment: Reasons and Impact
Subject: Economy
Section: External sector
- Withdrawal Amount:
- FPIs have pulled out ₹8,089 crore from the debt Voluntary Retention Route (VRR) segment after four consecutive years of inflows.
- Reasons for Withdrawal:
- Lack of Investment Opportunities: FPIs cite a dearth of opportunities to invest in stressed or structured credit as a primary reason for the withdrawal.
- End of Withholding Tax Benefit: The end of the withholding tax benefit has influenced FPIs to reconsider their investment strategies in the Indian debt market.
- Reduced Promoter Leverage: Opportunities that were once available due to promoter financing have diminished as promoter leverage in the corporate sector has significantly reduced.
- Contrast with Overall Debt Market Inflows:
- In contrast to the outflows from the VRR segment, the overall Indian debt market has witnessed significant inflows, exceeding ₹80,000 crore. This surge is attributed to potential front-loaded flows ahead of India’s inclusion in global bond indices.
- Voluntary Retention Route (VRR):
- Introduced in March 2019, VRR aims to attract long-term overseas investments into the Indian debt market.
- Investments through VRR are exempt from certain regulatory norms applicable to regular FPI investments.
- Impact of Tax Policy Changes:
- The withdrawal is partly attributed to the impact of tax policy changes, especially the end of the 5% concessional tax rate, resulting in an effective withholding tax of 20% on rupee-denominated bonds.
- Investor Sentiment and Fiscal Approach:
- The outflows underscore the significance of tax policy changes in shaping investor sentiment.
- Emphasizes the need for a balanced fiscal approach to maintain market competitiveness, according to industry experts.
- Currency Hedging and Developed Markets:
- After accounting for currency hedging costs, it may be more advantageous for FPIs to stay invested in developed markets like the US, where yields have increased significantly across maturities.
In summary, the withdrawal of FPIs from the debt VRR segment reflects a combination of factors, including a scarcity of attractive investment opportunities, changes in tax policies, and reduced opportunities in the corporate sector. The contrasting inflows into the broader debt market suggest varied investor strategies and considerations.
Voluntary Retention Route (VRR):
- Introduction:
- VRR, or Voluntary Retention Route, is a scheme introduced by the Reserve Bank of India (RBI) in March 2019.
- Objective:
- The primary goal of VRR is to attract long-term foreign portfolio investments into the Indian debt market.
- VRR is designed as a voluntary scheme for Foreign Portfolio Investors (FPIs) looking to invest in debt instruments in India.
- Regulatory Norms:
- Investments made through the VRR route are exempt from certain macroprudential and regulatory norms that typically apply to regular FPI investments.
- Long-Term Commitment:
- The scheme encourages FPIs to make long-term commitments to the Indian debt market by offering certain exemptions and benefits.
- Macroeconomic Considerations:
- By providing a route with fewer regulatory restrictions, VRR aims to strike a balance between attracting foreign investments and ensuring macroeconomic stability.
- Types of Debt Instruments:
- FPIs can invest through VRR in various debt instruments, including government securities, treasury bills, corporate bonds, and other money market instruments.
- Auctions and Limit Acquisition:
- To invest through VRR, FPIs need to participate in periodic auctions conducted by the RBI.
- There is a limit on the total amount of investment that can be acquired through the VRR route.
In summary, VRR is a specialized route introduced by the RBI to attract and facilitate long-term foreign investments in the Indian debt market, offering exemptions from certain regulatory norms to encourage FPIs to make sustained commitments.
Front-Loading in Debt Market by Foreign Portfolio Investors (FPIs):
- Strategy Overview:
- In the debt market, FPIs are employing a strategy known as “front-loading.”
- This involves accelerating government securities purchases in anticipation of India’s bond inclusion in global indices starting June 2024.
- Purpose of Front-Loading:
- The primary goal of front-loading is to position FPIs advantageously ahead of the anticipated increase in demand for Indian bonds due to global index inclusion.
- Bond Inclusion in Global Indices:
- India’s government securities are expected to be included in global indices from June 2024.
- This inclusion is likely to attract significant attention from international investors tracking these indices.
- Positive Factors Influencing Strategy:
- Stability of the Rupee: The stability of the Indian rupee is identified as a positive factor influencing FPI strategies in the fixed-income space.
- Core Inflation Below 4%: Another positive factor is the core inflation falling below the 4% mark, contributing to the attractiveness of Indian debt.
- Record Investment in Indian Debt Markets:
- FPIs executed a front-loading strategy by injecting a record ₹15,647 crore into Indian debt markets in the first three weeks of January 2024.
- This substantial investment builds on the momentum observed in 2023 when total debt inflows reached a six-year high of $7.3 billion.
- Anticipation of Favorable Market Conditions:
- Experts anticipate that FPIs are positioning themselves early to benefit from potentially favorable market conditions once India’s bonds are included in global indices.
- The early investment is seen as a proactive approach to capitalize on the expected surge in demand.
In summary, front-loading in the debt market by FPIs reflects a strategic move to gain a competitive advantage and maximize returns in anticipation of increased demand for Indian government securities following their inclusion in global indices. Positive economic indicators, such as a stable rupee and lower core inflation, contribute to the attractiveness of this investment strategy.
Rupee-Denominated Bonds:
- Introduction:
- Rupee-denominated bonds, also known as Masala bonds, are debt instruments issued in Indian rupees by entities, including Indian and foreign companies, in the international markets.
- Currency of Denomination:
- Unlike traditional bonds, which are denominated in major global currencies like the US Dollar or Euro, rupee-denominated bonds are issued in Indian rupees.
- Objective:
- The primary purpose of issuing rupee-denominated bonds is to allow entities to raise capital in international markets without being exposed to currency risk. Investors bear the currency risk in these bonds.
- Interest Payments and Principal Repayment:
- Interest payments and the repayment of the principal amount are made in Indian rupees, providing clarity to both the issuer and the investor about cash flows.
- Masala Bonds Terminology:
- The term “Masala bonds” gained popularity as a colloquial name for rupee-denominated bonds, reflecting the Indian currency and adding a cultural touch.
- Issuers of Rupee-Denominated Bonds:
- Indian entities, including corporations and financial institutions, may issue rupee-denominated bonds in the international markets.
- Foreign entities, especially those interested in raising funds for investments in India, may also issue such bonds.
- Investor Base:
- Rupee-denominated bonds attract a diverse set of investors, including global investors seeking exposure to the Indian market and Indian diaspora interested in supporting Indian entities.
- Risk and Returns:
- Investors in rupee-denominated bonds are exposed to currency risk, as the value of the Indian rupee against other currencies can fluctuate.
- The interest rates offered on these bonds are influenced by market conditions and issuer creditworthiness.
- Tax Implications:
- The tax treatment of interest income earned on rupee-denominated bonds may vary depending on the jurisdiction and relevant tax laws.
- Regulatory Framework:
- The issuance and trading of rupee-denominated bonds are subject to regulatory guidelines set by authorities in both the issuer’s country and the international market.
- Growing Popularity:
- Rupee-denominated bonds have gained popularity as an alternative fundraising avenue for Indian entities and as an investment option for global investors looking to diversify their portfolios.
In summary, rupee-denominated bonds provide a unique avenue for entities to tap into international capital markets while allowing investors to gain exposure to the Indian economy, albeit with associated currency risk.