• UGI USER
  • Aug 03, 2024
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GOVT, RBI CAUTIOUS ON FOREIGN BOND INFLOWS

Syllabus:

GS 3:

  • Mobilization of Resources
  • Liberalisation of Economy

Why in the News?

Government of India and RBI have decided to exclude new 14-year and 30-year New Long term government bonds from the Fully Accessible Route (FAR) amid rising foreign investments, aiming to manage potential risks and inflationary pressures.

 Source: RBI

Introduction

  • Recently, the Indian government and the Reserve Bank of India (RBI) have adopted a cautious stance regarding unrestricted foreign fund flows into long-term government bonds.
  • This shift follows the inclusion of Indian government bonds (IGBs) in JP Morgan’s emerging markets bond indices.

Why has this sudden caution emerged?

  • The exclusion of bonds with 14-year and 30-year tenors from the Fully Accessible Route (FAR) highlights concerns over potential uncertainties and risks associated with increased foreign portfolio investor (FPI) inflows.
  • The phased inclusion of Indian bonds into the GBI-EM Global Diversified Index (GBI-EM GD) will begin starting June 28, 2024 till march 2025.
Fully Accessible Route (FAR)

  • Fully Accessible Route (FAR) allows certain categories of Central Government securities to be fully accessible to non-resident investors without restrictions.
  • These securities are also available to domestic investors.
  • FAR regulations began on April 1, 2020.

Features

  • Eligibility Notification: The Reserve Bank of India (RBI) designates which government securities can be bought under FAR. Once designated, these securities remain eligible for FAR investment until they mature.
  • Specific Securities: Government securities listed in the FAR are open for investment from the scheme’s start date. Additionally, new issuances of 5-year, 10-year, and 30-year government securities from FY 2020-21 are included under FAR.
  • Flexibility: The RBI can add or change the tenors of securities eligible for FAR.

Impact of Government Securities Inclusion in Indices

Estimated Inflows and Benefits

  • The inclusion of government securities (G-secs) in indices over a 10-month period, ending March 31, 2025, is expected to attract approximately $20-25 billion.
  • This influx is anticipated to enhance India’s external finances, foreign exchange reserves, and strengthen the rupee.

Inflationary Concerns

  • However, increased foreign portfolio investment could trigger inflationary pressures.
  • The Reserve Bank of India will need to employ its policy tools to mitigate these potential inflationary effects.

Clarification on Changes to the FAR Route

  • No Policy Flip-Flop: The recent changes to the Fully Accessible Route (FAR) are not a reversal or an attempt to deter foreign investors.
  • New System: Previously, the FAR was open to all. Now, the approach requires approval for new long-term government securities. Existing securities remain accessible under FAR.
  • Specific Exclusions: The only modification is the exclusion of new government securities with 14-year and 30-year tenors from the FAR.

Rationale Behind Recent FAR Changes

  • Current Foreign Investment: Out of the total available government securities worth Rs 41 lakh crore, foreign investment amounts to approximately Rs 2 lakh crore.
  • Prudential Debt Management: The adjustment aims to manage debt prudently, as past crises have seen countries depleting dollar reserves.
  • No Deterrence: The decision is not intended to discourage foreign investors but to manage dollar inflows more carefully.

RBI Announcement on Fully Accessible Route

  • Exclusion of Long-Term Securities: The RBI announced that new government securities with 14-year and 30-year tenors will be excluded from the Fully Accessible Route (FAR).
  • Consultation and Decision: This decision was made after a review and consultation with the government.

Overview of the FAR Route and Foreign Investment

  • Introduction of FAR: The FAR route was introduced in March 2020, alongside the Medium-Term Framework (MTF) and the Voluntary Retention Route (VRR).
  • Current FPI Limit: The limit for foreign portfolio investment (FPI) in long-term government bonds is Rs 137,984 crore.
  • Investment Data: According to NSDL data, Rs 5,174 crore was invested in long-term government securities through the FAR route. This included Rs 70 crore in 7.72% G-secs maturing in 2049, Rs 1,004.48 crore in 7.16% G-secs of 2050, and Rs 3,486.50 crore in 6.67% G-secs maturing in 2050.
  • Investment Before Exclusion: Before the exclusion of new long-term securities, nearly Rs 1.32 lakh crore was available for FPIs.
  • Impact of FPI Flows: FPI flows, often termed hot money, caused market fluctuations. In 2024, FPIs invested Rs 92,696 crore in debt securities.

Impact of Increased FPI Inflows

  • Impact on the Rupee: Higher foreign portfolio investment (FPI) inflows are expected to strengthen the rupee.
  • Inflation Concerns: As the RBI absorbs dollars from the market, it must release an equivalent amount in rupees, which could increase inflationary pressures.

JP Morgan’s Index Inclusion Criteria 

  • Eligibility for Index: only government securities (G-Secs) designated under the Fully Accessible Route (FAR) are eligible for inclusion in the index.
  • Inclusion Criteria: To qualify, instruments must have a notional outstanding of over $1 billion and at least 2.5 years of remaining maturity.
  • Initial Assessment: Starting June 28, 2024, only FAR-designated Indian government bonds (IGBs) maturing after December 31, 2026, will be considered.
  • Phase-In Additions: New eligible FAR-designated IGBs issued during the phase-in period will also be included.

Factors Influencing Indian Authorities’ Cautious Approach

  • Recent Developments: After JP Morgan’s announcement, Bloomberg also revealed in March that Indian government bonds will be included in the Bloomberg Emerging Market (EM) Local Currency Government Index and related indices starting January 31, 2025.
  • Initial Weight: Indian FAR bonds will have an initial weight of 10% of their full market value in the Bloomberg EM Local Currency Government indices from January 31, 2025.

Impact of Bond Inclusion on Foreign Investments

  • Attractive Returns: Foreign investors are drawn to India’s higher bond returns of over 7%, compared to the US returns of around 5%.
  • Increased FPI Interest: The inclusion of Indian bonds in global indices could attract more foreign portfolio investors (FPIs) to India.
  • Inflation and Rate Cuts: This influx may pressure inflation and delay potential interest rate cuts by the Reserve Bank of India (RBI) later this year. Analysts anticipate the RBI might reduce interest rates either later this year or early next year.

Current Economic Outlook for India

  • Economic Growth: The Economic Survey forecasts a growth rate of 6.5-7% for India.
  • Stock Market Performance: The Sensex has reached 82,000, and the Nifty has surpassed 25,000 during the current bull run.
  • Foreign Exchange Reserves: India’s foreign exchange reserves stand at a strong $670 billion.

Conclusion

The exclusion of long-term bonds from the Fully Accessible Route (FAR) aims to manage foreign investment risks and control inflation. As India integrates its bonds into global indices, careful monitoring will be essential to balance growth and economic stability.

Source:The Indian Express

Mains Practice Question:

Examine the role of foreign portfolio investments (FPIs) in India’s government bond market and discuss how fluctuations in these investments can influence the overall economic stability of the country.

Associated Article:

https://universalinstitutions.com/rbi-and-monetary-policy-in-india/