No one can accuse the new RBI governor, Dr Raghuram Rajan, of sleeping on the job. The latest circular in a string of announcements coming from India’s central bank amends rules for foreign investors in India. The changes prohibit foreign investors from buying corporate bonds with maturities of less than three years, but they are also now able to reinvest government bond coupons.
While the new rules are expected to result in an initial decrease in foreign investor demand for Indian debt, in the longer term they should help India deter hot money heading into its bond markets.
History has taught the country that when markets look good, investors will flood to its securities. But when adverse global news shakes up the buyside, the money can flee just as quickly.
Low interest rates in developed markets following quantitative easing by the US Federal Reserve after the global financial crisis sent investors running to emerging markets in search of higher yields. But in May 2013, an announcement by then Fed chairman Ben Bernanke that the central bank would begin tapering QE led investors to pull their money out of India’s stock and bond markets and caused a sharp fall in the value of the rupee against the dollar.
It was a lesson learned, and one that is more important than ever as current global central bank divergence looks like it’s setting up a similar scene for India.
Since the start of this year the outlook for emerging markets has dimmed somewhat. But India has been repeatedly highlighted as a bright spot in Asia. As a net oil importer and beneficiary of low commodity prices, as well as possessing a government pushing positive reforms under new prime minister Narendra Modi, India is again a go-to market for yield chasers.
This is underpinned by data showing that foreign investors had used up 69.3% of their corporate bond quota as of February 9, up from 37.4% in July. And they have used up 99% of their quota for government bonds.
Taking the long view
The RBI could have easily taken advantage of investor sentiment and upped the foreign investor quotas. But instead the central bank has quite rightly approached global uncertainty as a potential instigator of same hot money situation India saw in 2013.
Not that the bank is trying to shut investors out. The re-investment of government bond coupons is not included in the quota, allowing for a slight increase in the amount foreign funds can invest.
But the new rules for corporate bonds will force foreign investors to consider the credit quality of what they are investing in — investors will automatically be more diligent about credits they have to hold for longer periods of time. That extra consideration ought in turn to mean that those investors would also be more likely to stick with their investments despite global shocks.
All of which suggests that these changes offer hope of improved Indian bond markets in the future. Investors holding better credits for longer is a worthy objective, and one that would be likely to increase demand for Indian debt longer term.
If Raghuram Rajan doesn't already play chess, then he should take it up: he's clearly got a knack for thinking 10 moves ahead.