Why G-sec auction failed to lure FIIs? Experts discuss

The auction to buy nearly Rs 28,500 crore worth of government bond limits received bids for just Rs 20,496 crore. Meanwhile, only Rs 19,777 crore out of Rs 31,387 worth of corporate bond limits were sold.

FIIs pay a premium for buying the permit to buy the bonds. The highest bid to buy a G-sec permit was just 0.01 basis points, which means even if they let it lapse they wont lose much.

In an interview to CNBC-TV18 Ashish Vaidya, head- FICC Trading, UBS and Sameer Goel, Head Asia Rates & Currency Research, Deutsche Bank explained the reason for poor appetite among foreign investors to buy Indian government and corporate bonds, despite relaxed conditions.

Bleak macro-economic outlook and policy paralysis is keeping foreign inventors from investing in India, said Goel. "We will require to see some progress on that before you see genuine interest from offshore investors come in a very significant manner."

Agreeing to the reason citied by Goel, Vaidya also highlighted that this auction might not have been an attraction for arbitrage players also because of the hedging cost of rupee involved.

"Any arbitrage player would want to hedge the dollars, so if he hedges the dollars, pays about 6-6.5% and if his internal funding cost is say 100-150 basis points it hardly leaves 50 basis points on the table," he said.

Below is the edited transcript of the interview. Also watch the accompanying videos.

Q: What are your key takeaways from this event what explains this complete lack of interest on the part of FIIs?

Goel: The auction for the quotas is not a surprise. This is ultimately an auction to buy the right to buy government bonds. We must also see that these are now auctioned every month on a more regular basis, so that is the positive side of it.

Investors now have the option to buy this quota on a more regular basis that has driven down the premium people paid on this quota because the quota is now attached to the bonds you buy. If you sell the bonds you also lose the quota so it has become a more tradable instrument to that degree.

Q: Give us a sense in terms of this 72% subscription that we did see or the interest that we did see, what sort of investors actually came in? What was the type of FII investor we were looking at?

Vaidya: We really don’t have the break up of the type of FIIs. But if the real money guys if they are interested and they are ready to take an open risk on the INR then it clearly makes sense for an investor to come in.

This does not augur very well for the arbitrage players because after taking off the hedging cost of US dollar INR it leaves nothing much on the table for an arbitrage player.

Q: Would you agree with what Sameer that there is a broader macro India story that is going and that is creating disinterest or is it something else like for instance, one would always think that the arbitrage play, the interest rate that India offers 8-9% would be an attraction, not so?

Vaidya: There is a hedging cost of rupee involved. Any arbitrage player would want to hedge the dollars, so if he hedges the dollars and if he actually pays about 6-6.5% and if his internal funding cost is say 100-150 basis points it hardly leaves 50 basis points on the table.

So the arbitrage players will obviously step back and they will always be there despite whatever this story is there on the India macro. However, having said that I do agree with Sameer because broadly people look at areas and investor segments which are particularly impressive only if the overall macros attractive.

Q: Was one factor the potential of rating downgrade because then a lot of people can’t even apply for these bonds was that a factor at all you think?

Goel: The possibility of a ratings downgrade and that the agencies have put us on watch is certainly an important element. It differs according to investor classes that there is not necessarily all investors who would shy away from the market just because ratings go from being investment grade to being sub investment grade.

Nevertheless a lot of investable criteria’s are linked to ratings. For the new investor who might wants to get into India the prospect of any ratings action in the next six months would certainly be an important factor.