RBI favours caution in fully opening up debt market to foreign investors

Official raises concerns over unhedged foreign currency exposure by Indian borrowers in offshore debt

There is a need to proceed cautiously in fully opening up debt market to foreign investors, given the need to first deal with issues such as the large government borrowing and capital controls, said the Reserve Bank of India's (RBI) executive director G Padmanabhan in a speech last week in Brussels

Padmanabhan also raised concerns over the unhedged foreign currency exposure by Indian borrowers in offshore debt, saying it raised "systemic concerns."

 “At a micro level, individual entities may well be able to tide over any exchange rate stock, but at a macro level when everybody scurries for cover, the market impact may be unsettling,” he said.

 

Padmanabhan cited "structural frictions" in India's bond and currency markets, including large government borrowings, as reasons that justified proceeding in a non-disruptive manner on enhancing debt limits for foreign investors. Currently, foreign investors can buy up to $ 30 billion of government bonds and $ 50 billion of corporate bonds.

Every year the rupee has been depreciating at about 5 per cent while the cost of a swap today is about 6-7 per cent. According to Padmanabhan this acts as a disincentive. “There is a need to align individual incentives with that of the system. Use of options and what is called option trading strategies can contribute in this and therefore, the regime has to consider permitting this,” he said.

He added that two specific enablements that RBI is actively considering in this direction are permitting covered option writing and relaxing the net worth criteria for using option strategies to hedge exposures. 

Currently capital account convertibility is not permitted. Padmanabhan believes that unless capital account liberalisation is accompanied by achievement of certain ‘thresholds’and financial and institutional developments, the costs may far outweigh the benefits. 

Speaking about the complexities of derivative products Padmanabhan said that banks will have to put in place a framework for testing the appropriateness of the product used for their clients.

“Foreign Exchange Dealers’ Association of India (FEDAI) has an important role to play in this. The idea must be to prevent mis-selling rather than penalise such actions. Recently, it came as a great shock for me to learn that some of our exchanges do not have systems to upfront prevent self trades. They rather believed in tracking and penalising self trades. This to my mind is an inefficient approach to the issue,” he said.