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At $13.4 bn, FII flows into debt outpace equity flows

Foreign portfolio investors are the sultans of Indian equities, given that they own 22% of BSE 500, second only to Indian promoters who control 28% of the universe. A quarter of India’s largest companies are owned by FIIs and the value of their equity ownership stands at a staggering $ 315 billion. Through the last five years, when economic growth has halved, calendar year 2014 is no different, but there is an interesting shift that has happened this year. Foreign portfolio investors have pumped in $ 13.4 billion in debt and $ 12.2 billion into equities. For the first time, FII flows into debt have surpassed equity flows. Strategists believe this signifies the deepening of India’s financial markets.

Equities have always been the preferred investment for FIIs against debt. Since 2010, FIIs have pumped in $ 39 billion into debt against a staggering $ 86 billion into equities. This year, however, could be different, if debt flows continue to outpace equity flows. So far there has been a reluctance to open up the Indian debt market, but with the fiscal condition improving and currency stabilizing, treasury heads expect the flows into Indian bonds remain strong if debt limits continue to open up. Anindya Dasgupta, treasurer at Barclays, says: “There is an appetite for Indian paper and if bond limits continue to open up, more flows could come in. However, the opening up of the Indian debt market is likely to be gradual.”

Bank of America Merrill Lynch expects the government to raise FIIs’ limits for on-auction G-Sec by $ 5 billion to $ 30 billion, doing away with the separate limit for sovereign wealth funds. This month, FIIs hit 97.4% of their limits as they pumped in $ 2.6 billion into Indian gilts. Opening up of limits may help the RBI build a stronger war chest to combat a contagion later next year, once the US Federal Reserve hikes interest rates.

Type of Investment Upper Cap ($ bn) Upper Cap (Rs crore) Current Usage (Rs crore) % of limit exhausted Free limit (Rs crore)
Govt Debt (auction) 25 124 , 400 103,400 97% 21, 000
Govt Debt (on Tap) 5 29,100 13,600 47% 15,500
Treasury Bills 5.5 25,400 8,300 33% 17,100
Corporate Debt 51 244,300 97,500 40% 146,800
Commercial Papers 2 100 http://bsmum.bsmail.in/icons/ecblank.gif 96% 4
Credit Enhanced Bonds 5 24,000   24,000
Source NSDL, SEBI, Citi      

Higher flows into Indian debt is also a sign that India’s financial markets are broadening with new tilts. According to Citi, “FII debt flows are accelerating, at $ 13.4 billion year-to-date, they exceed equity flows, and there’s more investment headroom. This is broadening India’s markets: and with new tilts should continue to liven them up.” With not much headroom left for FIIs in the equities space, with them nearly hitting the permissible limits, the focus is now shifting to Indian debt. This shift is perceptible as this is the  first time that debt flows have outpaced equity inflows and the trend may continue through the year, as FIIs have more headroom to invest in debt than in equities.

For three consecutive years, FII inflows into equities has been very strong, ($ 24 billion in 2012 and $ 21 billion in 2013), but the massive swing this year has been in debt. For the first time since 2000, FII flows into debt have crossed $ 10 billion. For the full year, FII flows into debt were at $ 10 billion in 2010 while FII flows into equity that year were at $ 29 billion. According to Citi, there is significant headroom left for FII investments in debt. While some of this money may leave the country if interest rates rise in the US from mid-2015, treasury heads believe that interest in Indian debt would continue as global investors would view India as an opportunity as a portfolio diversification strategy. That India’s markets are deepening is also a source of confidence.

The equity bulls may not agree, given that there are a large number of offer for sales (OFS) lined up by the government in listed public sector companies, but equity strategists believe that the FII flows into equities in the cash market have already eased and that the junk rally may not last at all. According to Gaurav Mehta of Ambit Capital, “The past few months have seen ‘junk’ shoot through the roof. Historically such periods of ‘junk’ outperformance are usually short-lived and a deluge of QIPs is often the trigger deflating their rally. We have been flagging a similar deluge since early July and believe the past month’s price action may have just marked the beginning of the end of junk’s outperformance for the foreseeable future.”

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