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stock of domestic bonds now exceeds $6 trillion, compared to only $1 trillion in the mid-1990s. Along with this, foreign participation has also increased substantially over the last decade. In contrast, the Indian policy framework on debt flows, characterised by quantitative restrictions on foreign participation, has resulted in limited foreign investment. There is a strong case for opening up the local currency government and corporate debt market to foreign investors.
The present arrangement governing foreign borrowing comprises two parts. First, dollar denominated debt: India raises capital through foreign currency denominated debt via government borrowing (both bilateral and multilateral), ECBs by firms (including foreign currency convertible bonds and foreign currency exchangeable bonds) and fully repatriable NRI deposits. Second, rupee denominated debt: Foreign investment in rupee denominated debt takes the form of foreign investors buying bonds in the Indian debt market, which is denominated in rupees. This is subject to an array of quantitative restrictions. There are different limits for foreign investment in government and corporate bonds. This arrangement is further complicated by sub-limits across assets and investor classes.
The share of outstanding government bonds that are owned by foreign investors has risen through the years. As of March 2013, it stands at 1.6 per cent. In absolute numbers, foreign investors own Rs 700 billion or approximately $11 billion of Indian government bonds. At present, the quantitative restriction on foreign investment in government bonds stands at $30 billion. The small scale of foreign ownership implies a substantial upside potential. The internal debt of the government stands at Rs 48.7 trillion. Government securities account for 90 per cent of this amount. Even if the ownership of foreign investors went up by ten times overnight, to $110 billion, it would only amount to 16 per cent of the existing stock of bonds.
A comparison with other emerging economies shows that India greatly lags behind in the proportion of government bonds owned by foreigners. This raises questions on the structure of capital controls in the rupee denominated bond market.
The Working Group on Foreign Investment, chaired by U.K. Sinha, pointed out that the existing regulations create incentives for Indian firms to favour foreign currency borrowings over issuing debt denominated in rupees. It recommended easing the restrictions on rupee denominated debt as a safer way to manage globalisation. The Committee on Financial Sector Reforms, chaired by Raghuram Rajan, also recommended the steady opening up of rupee denominated government