Foreign Portfolio Investors Withdraw Almost $1 Billion From Indian Long-Term Debt

Foreign Portfolio Investors (FPIs) have recently withdrawn a significant sum of approximately 8,089 crore rupees (nearly $1 billion) from the long-term debt market in India, specifically from the debt Voluntary Retention Route (VRR) category. This move comes on the back of several contributing factors, highlighting changes in the investment landscape.

Challenges Leading to FPI Withdrawal

Primarily, the lack of investment opportunities in stressed or structured credit markets has dampened investor interest. There has also been a noticeable scarcity in the number of auctions, an essential mechanism for acquiring VRR limits by new investors. The conclusion of a beneficial withholding tax regime has further influenced investor decisions. A 5% concessionary tax rate previously applied to such investments ended last year, sharply increasing to the standard rate of 20%, consequently diminishing the post-tax returns for FPIs.

Impact of Withholding Tax Benefit End

Investors with a three-year investment horizon are particularly impacted by this shift in tax policy. The increase in effective withholding tax reduces the actual return on investment for FPIs, which, when coupled with the increased currency hedging costs, makes investments in developed markets with rising yields such as the US more appealing. The potential for further depreciation of the rupee against the dollar also acts as a deterrent to maintain debt investments in India.

If an investor were to consider the practical implications of the tax hike, the additional tax burden would substantially cut down their earnings. For instance, on a bond investment worth 1,000 rupees with a 10% coupon rate, the tax increase from 5% to 20% results in a 27% reduction in income when adjusted for a 4% annual hedging cost.

The Outlook for India's Debt VRR

Moreover, the VRR mechanism obliges investors to retain at least 75% of their investments for a minimum of three years, a commitment that some investors may not find feasible under current conditions. Despite the challenges, the investment limit under this segment has been raised, showing an intent to attract more foreign investment. However, investor sentiment remains volatile and is susceptible to changes in market conditions both domestically and globally.

FPIs, withdrawal, debt