How government’s 5 CAD fixes will impact markets

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The government’s proposed move to remove caps on foreign investor holding of corporate bonds and make the job raising overseas loans and bonds easier could help lift the pressure on the rupee and arrest rising bond yields, traders and investors said.

The local currency may now head north amidst an expected bout of overseas fund flows triggered by these policy changes.

“The measures should yield results impacting the exchange rate,” said MS Gopikrishnan, head of macro trading, South Asia at Standard Chartered Bank. “The authorities are trying to address the CAD while improving dollar flows to finance the same.

To address issue of expanding current account deficit or excess of overseas spending over revenues, the government will also take necessary steps to cut down non-essential imports while focussing more on exports, Mr Jaitley said. India’s CAD widened to a four-quarter-high at 2.4% of gross domestic product (GDP) in April-June on the back of rising crude oil prices. The rupee has now fallen about 12% this year forcing the government to undertake emergency measures to rein in imports and increase foreign fund flows.

The government also proposed yesterday to remove exposure limits of upto 20% of an FPI bond portfolio to a single corporate group, and 50% to a single company. RBI tightened foreign bond purchases in April this year in an attempt to restrict the flow of hot money into Indian markets. But this ended up creating confusion among foreign bankers who help overseas clients to buy domestic paper.

Overseas investors can invest in Indian corporate bonds up to Rs 2.67 lakh crore in a year. Last year, investors used up the limit to about 80-90% but that figure has now dropped to just 76% as global investors shied away from Indian corporate debt papers.

“These measures are enablers to check the rupee’s slide,” said Jayesh Mehta, MD at Bank of America Merrill Lynch. “Overseas investment in debt securities is likely to rise over a period of time after the government proposed to remove caps, introduced earlier in April. Such measures would lift the markets on Monday,” he said.

The government has also eased norms for the rupee-denominated masala bonds, which have lost sheen of late. Withholding tax now at 5% is seen as a drag hindering easy issuance of masala bonds.

With the latest relaxtion in masala bonds, it will help getting more dollars flows aiding Domestic Borrowers- of which those NBFCs are a key component,” said Ajay Marwaha, director for investments at Sun Global Investments in London. Withholding tax removal, coupled with emerging stability in the INR will ensure masala bonds regain momentum as a key financing instrument for Indian Growth” he said.

Masala Bonds will now be exempt from witholding tax for issuance done this year that is upto 31 March 2019, the finance minister Arun Jaitley said. He said that the RBI & DEA have given suggestions which will be implemented in the next few days.

“With today’s relaxations on ECBs and Masala Bonds, the RBI & the government appear to be encouraging domestic entities and foreign investors to bet on the rupee, and bring in some opportunistic foreign currency,” said Ananth Narayan, associate professor of finance at SP Jain Institute of Management and Research.

The steps on the actual structural issue – our bulging current account deficit – are still awaited,” he said.

Source: Economic Times