RBI concerned about FII debt flows

Last Updated: Mon, Nov 19, 2012 19:30 hrs

The Reserve Bank of India (RBI) has raised concern on debt flows by foreign institutional investors (FIIs) in the capital market. RBI Deputy Governor H R Khan said there was a need to reduce debt inflows, which, due to interest rate differentials, had have come at a very quick pace.

According to data with the Securities and Exchange Board of India (Sebi) net investments by FIIs in debt rose 59 per cent to $6,814.22 million in the January-October period, compared with $4,290.65 million in the corresponding period last year.

Policies relating to FII investment in gilts and long-term infrastructure bonds were revised on November 30 2011 and June 25 this year, respectively. The current limit for FII investment in gilts is $20 billion (of which $10 billion has residual maturity of three years). For corporate bonds, it is $45 (of which $25 billion is in long-term infrastructure bonds). There are talks the limit may be enhanced further.

Tomorrow, Sebi would conduct an auction for investment of about Rs 10,000 crore in government and corporate debt securities by FIIs. Barclays Research has recommended FIIs bid for the investment limits at the coming auction and buy bonds, anticipating purchase of gilts through open market operations by RBI.

RBI Deputy Governor Subir Gokarn said capital controls were imposed to limit short-term inflows, owing to concern on increasing volatility and monetary stability. He said short-term inflows often reflected high domestic interest rate differentials in the context of pegged or heavily managed exchange rate regimes. This often gave markets a false sense of security, he added. “Another important reason in imposing controls on capital inflows is to limit sterilisation and the associated quasi-fiscal costs of a central bank. Further continuous sterilisation may increase interest rates, which again encourage inflows,” he said.

As inflows increase, they lead to real appreciation of the domestic current. This reduced export competitiveness and made the balance of payments vulnerable, said Gokarn. “Capital controls are also imposed to alter the composition of capital inflows and create a hierarchy of flows, as short-term inflows are found to be more prone to crisis,” he said. “The country’s experiences indicate such restrictions have mainly been applied to short-term capital transactions to counter volatile speculative flows that threatened to undermine the stability of the exchange rate and deplete foreign exchange reserves,” he added.

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