FPI framework to alleviate 'hot money' outflows issues: IRR Report

Mumbai: The new framework on foreign portfolio investment (FPI) limits in government bonds will deepen the market and also reduce 'hot money' outflow concerns in case of resurgence of global volatility, according to a report by India Ratings and research (IRR).

"The guidelines on foreign portfolio investment (FPI) limits in G-secs will help broaden participation across the yield curve, help investors plan allocations systematically and alleviate concerns over 'hot money' outflows in the event of global volatility resurgence," the ratings agency said.

In its monetary policy review on September 29, RBI announced an increase in FPI investment limit in government bonds in phases to 5 per cent of the outstanding stock by March 2018. RBI said the existing requirement of investments being made in G-sec, including state development loans with a minimum residual maturity of three years will continue.

Limits for the residual period of the current financial year would be increased in two tranches from October 12, 2015 and January 1, 2016. Each tranche would entail an increase in limits by Rs 13,000 crore.

The report said once the Rs 13,000 crore FPI limit opens, flows will spread across the yield curve though short-end curve outperformed in the past fortnight.

The G-sec yield curve will gradually shift downwards. "While the benchmark 10-year bond may remain around 7.5 per cent during this week, other parts of the curve may see further softening of yields in the range of 4-5 basis points," the report said.

The central bank also said there will be separate limit for investment by FPIs in the state development loans (SDLs), which will be increased in phases to reach 2 per cent of the outstanding stock by March 2018.

The rating agency said FPI investment in SDLs (Rs 3500 crore) will be gradual and may benefit certain states, initially. It further said industrial production for August is likely to have remained weak at 4.3 per cent, given decelerating exports and a lack of corporate   investment demand.

"While month-on-month inflation may increase, we believe that retail inflation for September at 3.9 per cent will undershoot the RBI's projection of 4.5 per cent for the month," the report said. The rating agency sees rupee gaining further on the release of the first tranche of g-sec limit under the FPI framework this week.

"The rupee after posting 1.2 per cent gains last week is set to gain further towards 64.5 in our view," it said.

However, further gains in the short-term may be capped on RBI reserves build-up, and may be affected from the potential weakness in equity-linked FPIs on weaker corporate earnings, the report said.