FIIs abandon debt on rising equity returns

Foreign institutional investors (FII) have dumped the debt market to make the most out of the rising equity market, which is showing signs of revival.

Between January and May 15 this year, FIIs have pulled out Rs 3,962 crore, or $1.96 billion, from the debt segment. Of this, they pulled out Rs 3,687.40 crore (or $1.03 billion) between March 8 — when the equity markets started to rise — and May 15, according to data from the stock exchanges.

FIIs have pulled out more than 90 per cent of the investments after the equity markets started rising. On May 18, when the trading was halted at both the stock exchanges after it hit the upper circuit barrier, FIIs invested around Rs 32 crore, or $6.7 million, in the debt market. The country’s debt market consists of government securities, commercial paper and corporate bonds.

“Generally, FIIs park temporary surplus funds in the debt market, while they start switching from debt to equity ones the market shows signs of revival in order to book benefit. They are basically equity investors waiting for the opportune moment to invest in equity,” said IDBI Gilts MD and CEO N S Venkatesh.

FIIs incur costs of one-year London Inter-Bank Offered Rate (Libor), which is around 1.80 per cent at present, and premia on 12-month forward, which is currently at 3 per cent.

Higher premia in the forward market implies a weaker rupee and a stronger dollar.

This results into an overall gain. For example: In India, one-year ‘AAA’ rated debt instrument fetches a return of 8.50-8.00 per cent. FIIs can enjoy an interest rate arbitrage of 3-3.5 per cent between overseas market and India.

Similarly, a five-year government paper due in 2014 is fetching 6 per cent return and results in an interest rate arbitrage of 1.20 per cent.

“We have seen a similar movement from equity to debt in January 2008 when the market dropped from its peak. There is suddenly a lot of activity in the debt market as FIIs are moving to competitive results,” said a dealer at a public sector bank.

Harihar Krishnamoorthy, treasurer with First Rand Bank, said the interest rates were ruling high in March compared to April.

Taking benefit of this trend, FIIs have a finite amount allotted for emerging markets such as India and when they see an upturn in equity market, they switch over to stock to earn better returns, he said.

Mostly, FIIs invest in short dated maturity a maximum of five years and treasury bills.

In January, the Securities Exchange Board of India has raised the limit on FII investments in debt to $6 billion for government securities and $15 billion for corporate bonds.

The corporate bonds had attracted a lot of overseas investment even after the cap was hiked, treasury officials said.