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Monday, March 16, 2009

Implementation of the QR on investments by foreigners into INR debt

One of the least sensible things that India does is to put restrictions on foreigners buying rupee-denominated bonds, despite their being one of the best possible channels through which India can get engaged into globalisation. In this area, policy makers in India are clearly out of touch with present knowledge. (Here is background, and for the conceptual picture, see : link, link, link).

Once this quantitative restriction (QR) is in place, there is an allocative question: Which firms are going to get these limits? SEBI has just released the names of the firms who have won allocations in an auction. While there was space of Rs.41,000 crore on offer, the bids seem to have only added up to Rs.29,000 crore. Does this mean there is no charge for these bidders? Still, this sets the stage for Rs.29,000 crore of investments in the corporate bond market over the next 1.5 months.


  1. Why do you say this is less than sensible??

    Allowing large foreign inflows in local currency (LC) bonds is simply another type of portfolio inflow. When mobile capital flees the country in a big way, as is happening now, it becomes tough to raise equity financing. A similar outflow from G-Secs, by foreigners, would require a much sharper fiscal adjustment than the government is capable of or a large buyer of last resort (hopefully not RBI!).

    For more on this... watch the massive downturns in Indonesian bond markets. Despite running near balanced budgets, and incurring a general government debt ratio of just 30% of GDP, large selloffs of central bank securities and treasury bonds by foreigners is becoming a real constraint on projected policy easing.

    Moral of the story is ... you either count foreign holdings of local currency government debt as external debt or be prepared to run far smaller fiscal deficits or even surpluses during times when broad BoP is in a surplus. If you're prepared to do neither of these, then to imply that such restrictions are "insensible" is inappropriate if not misguided.

  2. oh... and one more thing... you'd also need a lot more FX reserves. Reserve adequacy would have to account for ample coverage of reversible capital flows (including from govt bonds). If you don;t have the hard currency -- forget about expecting skittish foreigners providing teh financing for your stimulus; moreover, you'd have to come up with teh foreign currency if you wanted to intervene to 'smooth out' FX rate fluctuations.

  3. This is not the only “least sensible things” that India does. Restricting foreigners buying rupee-denominated bonds is non sensible and it is utterly nonsense. They should be allowed to take part as this can be the best possible way of getting forex fund and becoming a global citizen.

  4. In my opinion, interest rates can be much better modelled as mean reverting than equities.


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