To a market primed for more spectacular policy announcements such as foreign direct investment in retail, the actual measures announced by the Reserve Bank of India (RBI) on Monday, which focused primarily on the rupee, came as a disappointment. But given its constraints, the RBI has, in fact, done a good job of putting together a package that can support the flagging rupee. Of the various measures announced, the one that may prove most effective in bringing in dollar inflows immediately is the enhanced limit for foreign institutional investments in government securities. The overall limit for FII investments in gilts been raised from $15 to $20 billion, and up to $10 billion can now come into gilts with a residual maturity of three years (five years earlier). The Government had all along a somewhat rigid notion of what constitutes ‘hot money’, which it sought to discourage at least in the ‘sovereign debt’ market. The latest measure, by reducing the duration of gilts into which fresh investments can flow, has struck the right balance between ‘hot money’ flows and those that are likely to stay longer.

A similar balancing act is also evident in easing the entry barriers for new classes of investors, such as central banks, sovereign wealth funds and pension funds, to invest in gilts. Given the global shortage of investment-grade paper and yields of 8-9 per cent offered by Indian gilts, FIIs are quite likely to use this window of opportunity to its full limit. That FIIs find Indian gilts quite attractive, despite the weak rupee and the recent warnings by global rating agencies, is evident from the fact that over 90 per cent of the existing FII limit of $15 billion was already utilised by end-May 2012 (SEBI data). Also useful is the move to open up a new $10-billion window for select manufacturing and infrastructure companies to tap external commercial borrowings (ECBs), which should help reduce borrowing costs for leading members of corporate India. Though the rising cost of currency hedging has made ECBs less attractive than a year ago, quality borrowers may still be able to tap foreign funds at costs (inclusive of hedging) that are one or two percentage points below domestic levels. In contrast to the above, moves to make infrastructure debt funds more attractive by reducing the lock-in period and allowing qualified foreign investors to invest in them may not immediately make them attractive to such investors. Sectors such as power and telecom, most in need of funds at this juncture, are hamstrung by execution delays, an uncertain business outlook and high leverage, making them unappealing amid the global mood of extreme risk aversion.

Of course, whether even the above moves will bring in sufficient dollar inflows to counteract any wholesale withdrawal by portfolio investors, is open to question. But given the volatile nature of global capital flows and the extremely limited absorptive capacity of the Indian bond markets, one can hardly fault the RBI for allowing foreign capital into the Indian debt markets in measured doses.

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