Strong demand from FIIs for government debt quotas

By Archana Narayanan

MUMBAI (Reuters) - Foreign investors bid heavily in an auction for quotas to buy government bonds on Monday, even after Standard & Poor's reiterated its "negative" outlook for the country, as a cut in a key debt investment tax has contributed to a rally in markets.

India attracted 101.46 billion rupees worth of orders for quotas to buy government debt from foreign institutional investors (FIIs), far more than the 55.33 billion rupees on offer, according to two dealers who participated in the auction but who declined to be identified.

Foreign investors have bid heavily this year for such quotas.

The strong interest comes even after Standard & Poor's on Friday maintained its "negative" outlook on India's sovereign ratings, which analysts say should not have a long-term impact on markets

Bonds have surged to 3-1/2 year highs as sharply easing inflation spurs hopes that the Reserve Bank of India will continue to cut interest rates as early as its next policy review in June.

"Several factors might have contributed to strong bidding interest in today's FII debt limit auction: positive surprise on inflation, expectations of further rate cuts, and recent reduction in withholding tax to 5 percent," said Nagaraj Kulkarni, a senior rates strategist for South Asia at Standard Chartered Bank in Singapore.

The May auction is the first since India cut the withholding tax applied on interest income for foreign investors late last month, hoping to attract more funding to bridge its current account deficit and polish its reformist credentials.

The government also had relaxed ownership limits in Indian debt for overseas investors in early April.

After these measures, foreign investors have bought a net $1.63 billion worth of government bonds in May, more than $992.2 million for the whole of April, regulatory data shows.

The strong demand for debt quotas on Monday was also because the amount being auctioned was a fraction of the 291.08 billion rupees sold in April.

That was reflected in a surge in the cut-offs, meaning foreign investors were willing to pay much higher rates for the debt limits.

Almost all of the $25 billion limit for foreigners in government debt has been exhausted, while just under half of the corporate debt limit of $51 billion has been used, as per capital market regulator data until end of April.

India no longer auctions debt quotas for corporate bonds and sells them instead on a rolling basis.

Benchmark 10-year bonds have rallied this month, sending yields to as low as 7.32 percent on Friday, their lowest since December 2009.

Lower inflation data have spurred hopes the RBI could cut interest rates again after easing by a combined 75 basis points via three separate rate cuts this year.

These hopes are offsetting the potential risk of a downgrade in India, which has been under "negative" outlooks from S&P and Fitch Ratings since the middle of last year.

(Reporting by Archana Narayanan; Editing by Rafael Nam and Sunil Nair)