Foreign institutional investment (FIIs) in Indian bonds have got another shot in the arm after the government cut the withholding tax to 5% from 20% on Thursday. Bond dealers say this move would prompt FIIs to buy bonds aggressively as the returns will increase.
?This is a game-changer for FIIs. We will see the flows coming in but not immediately but within 2-3 months,? said Jayesh Mehta, managing director and head of treasury at Bank of America-Merrill Lynch.
In 2012-13, FIIs invested close to $5 billion in Indian bonds and on an outstanding basis have already used up 50% of the total investment limit of $75 billion. The withholding tax cut could prompt FIIs to use up the entire investment limit by end of the year, market participants said.
On Wednesday, finance minister P Chidambaram said that the withholding tax, charged on interest income, will be cut to 5% from 20% for foreign and qualified institutional investors. The change will be in force for two years starting June.
Dealers said that this could prompt even long-term bond buyers such as overseas pension funds and insurance companies to buy bonds.
As on March 31, FIIs had used 66% of the available limit of $25 in government bonds and about 45% of the limit of $50 in corporate bonds.
Foreign investors had been lobbying for a reduction of the withholding tax citing the hit on returns from such bonds owing to the steep 20% levy. This was perhaps the last roadblock in attracting more foreign inflows into the country for bridging the record high current account deficit of 6.7% of GDP.
Earlier, the Reserve Bank of India had simplified the debt limits by removing the sub-limits and keeping the overall investment ceiling in government bonds at $25 billion and corporate bonds at $50 billion.
Coupled with the withholding tax cut, bond buying by FIIs is likely to gallop, dealers said.
Expectations of interest rate cuts by the RBI in the next one year has prompted even long-term investors such as sovereign wealth funds and pension funds to buy Indian bonds, dealers said.
