Govt, RBI turn cautious over unrestricted foreign fund flows into longer term bonds

The inclusion of government securities (G-secs) in indices which will be spread over 10 months, i.e., till March 31, 2025, is likely to bring nearly $20-25 billion into the country, according to various estimates. While higher inflows will help India manage its external finances and boost the foreign exchange reserves and the rupee, the Reserve Bank will have to use the instruments in its armoury to check the resultant inflationary pressures.

Government sources said changes to the FAR route is not a policy flip flop or a policy to dissuade foreign investors. “The door was ajar till now and anyone could walk in. Now the system that we have put in place is different in the sense that you need to just knock and the door will be opened. All existing securities are available for FAR. There has been no policy flip flop. The only change that has been done is that new G-secs of 14-year and 30-year tenor have been excluded from FAR,” an official said.

The official said out of the total available securities of Rs 41 lakh crore, foreign investment is around Rs 2 lakh crore. “The principles of prudential debt management indicate that this has to be watched over because there has been a history of dollar drawdown in some countries during global crises. New (dated) securities were being issued, so the step was taken as part of prudent debt management. We are not dissuading anybody from coming in. The decision was taken to prudently manage dollar inflows,” official sources said.

“On a review and in consultation with the government, it has been decided to exclude all new securities of 14-year and 30-year tenors from the Fully Accessible Route. Consequently, future issuances of Government Securities in these tenors shall not be available for investment under the Fully Accessible Route,” the RBI said in a notification earlier this week.

The FAR route was opened up in March 2020. This scheme is supposed to operate along with the two existing routes — the Medium Term Framework (MTF) and the Voluntary Retention Route (VRR).
The current FPI limit in long-term government bonds is Rs 137,984 crore.

NSDL data shows that Rs 5,174 crore came to long-term G-Secs through the FAR route. This included Rs 683.70 crore in 7.72 per cent G-secs maturing in 2049, Rs 1,004.48 crore in 7.16 per cent G-secs of 2050 and Rs 3,486.50 crore in 6.67 per cent G-secs maturing in 2050. This means nearly Rs 1.32 lakh crore investment was available for FPIs before the exclusion.

Considered as hot money, FPI flows had created fluctuations in the market in the past. In the calendar year 2024, FPIs had invested Rs 92,696 crore in debt so far.

While higher inflows will boost the rupee, inflation is likely to come under pressure. When the RBI mops up dollars from the market, it will have to release an equivalent amount in the rupees, putting pressure on inflation.

JP Morgan said only G-Secs designated under the Fully Accessible Route are index eligible. As per the index inclusion criteria, eligible instruments are required to have notional outstanding above $1 billion (equivalent) and at least 2.5 years remaining maturity. “At the start of the inclusion on June 28, 2024, only FAR-designated IGBs with a maturity date after December 31, 2026, will be assessed for eligibility,” it said.
Any new index-eligible FAR-designated IGBs issued during the phase-in period will also be included.
What has added to the cautious approach by Indian authorities is after JP Morgan, Bloomberg, in March this year, announced the inclusion of Indian government bonds in the Bloomberg Emerging Market (EM) Local Currency Government Index and related indices from January 31, 2025. Indian FAR bonds will be included in the Bloomberg EM Local Currency Government indices with an initial weight of 10 per cent of their full market value on January 31, 2025, Bloomberg said.

“Foreign players look at the arbitrage opportunities. India offers higher returns of over 7 per cent while the returns in the US are around 5 per cent. Bond inclusion can propel more FPIs to look at India for investment. This can put pressure on inflation and delay the possibility of a rate cut by the Reserve bank of India later this year,” said a market source. Many analysts expect the RBI to bring down interest rates later this year or early next year.

The government is optimistic about the economic growth with the Economic Survey forecasting a 6.5-7 per cent growth and stock markets are in the middle of a bull run with the Sensex hitting 82,000 and Nifty piercing the 25,000 level. India’s foreign exchange reserves are at a comfortable level of $ 670 billion.