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Premium: FIIs are Running Away From Indian Debt

Deepak Shenoy6 min read
Quick Facts
What is "Premium: FIIs are Running Away From Indian Debt" about?
What category is this article in?
Premium
Who wrote this article?
Deepak Shenoy, Capitalmind's research team.
When was this article published?
Published 30 January 2014.
How long does this article take to read?
6 min read
What does the "The Taper is On. And FIIs are running." section say?
The US Fed will taper bond purchases to a smaller $65 billion a month, which could mean that India, which gets a trickle of these flows, might not.
What does the "RBI Will Swap Debt" section say?
In the webinar I mentioned the stress on the current 10 year bond (8.83%, Nov 2023) will be huge in April and May, considering the nearly 90,000 cr. that needs to be repaid in that time.
What does the "RBI Says Reserves are Fine; OMCs Will Pay Back" section say?
The RBI defended the rupee strongly, saying that it the situation was fine with the Oil Marketing Companies buying dollars from the market and that they have “enough” to pay back at least the first installment of the return of the swaps.
What does the "Disclaimer" section say?
Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion.

We had a great webinar yesterday, with my explaining my views on the RBI policy.

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You can download the video or view the recording anytime you like! You will need to click on the “View Recording” button.

Let’s augment that discussion a little bit. But before that, a quick piece of news.

The Taper is On. And FIIs are running.

The US Fed will taper bond purchases to a smaller $65 billion a month, which could mean that India, which gets a trickle of these flows, might not.

FIIs have been selling debt, rapidly, in the last few days. They’ve sold around Rs. 5,000 cr. of T-Bills in the last week, and an equivalent amount of government debt. A good chunk of the recent investment by FIIs in debt seems to have been in short term debt where they pumped in over Rs. 15,000 cr. ($2.5 billion) since December.

And the bond situation is now reversing trend fast, going down from the 78,000 cr. number to about 74,000 cr.:

In the equity markets, FIIs took out around 1,800 cr. in the last week.

Impact: FIIs have been responsible for a good portion of the gain in the last three months. All they need to do, honestly, is to NOT invest, and our markets will fall. Their exit from the debt markets is less worrisome for the debt market (they are a small part of the market there) and has greater implications for the rupee.

Our views:

  • Everyone expected a further taper, but markets are now starting to see an impact.

  • A low key expiry Thursday is likely to be followed by a sudden move on Friday, in the rupee and in the equity markets, both going down, in our opinion. But remember, this opinion will change on an hourly basis, on news and other market reactions.

  • In case the market dips below 6,000, we will see a marginal recovery and then another large move down. That would be a good time to set up protection for February with puts at the 6,000 level.

  • We see a 5% chance of the FIIs having already done the worst, and for markets to recover.

RBI Will Swap Debt

In the webinar I mentioned the stress on the current 10 year bond (8.83%, Nov 2023) will be huge in April and May, considering the nearly 90,000 cr. that needs to be repaid in that time.

However the RBI has said it will “swap” the big bubble debt repayments for longer term, well spread out payments so that this issue is resolved. They specifically said they would do this when the market will be less impacted.

Our analysis shows** the best window for the swap will probably have to be before March 15**, when there is a liquidity crunch due to another tax payment. After that, there is another policy statement on April 1, and then April brings with it a whole new borrowing schedule, a potential new issue of a 10 year bond (due to the change in financial year) and so on.

The issue with swapping this debt is that the owners of that old debt might not want to swap it. An insurance company or bank that is doing duration matching might not be able to handle a long bond swap. The FII which owns some of this debt might not want to roll it over. RBI might own this debt (through OMOs) which it cannot legally swap, since that is akin to financing the deficit.

This then spills over into the primary dealers or other banks, who will have to purchase this debt when it gets swapped; and those entities get overloaded and will have to offload those securities into the market to survive, which will drop prices.

**If this swap is done before March 2014, the impact on the 10 year bond yield will be lower. **The lower impact is only because of lesser fresh bond issuance - the government will have finished its borrowing program very soon. But the current 10 year bond is going to have to face a major problem in terms of price pressure after 15th March, regardless.

Impact: Fixed income portfolios should remain concentrated at the short end of the curve, please. To our discredit, the short end seems to have slipped as well - the 182 day T-Bill today auctioned at 8.94%, while the 10 year remained at 8.77%, giving us a glimpse of an inverted yield curve all over again. However, short-term bonds will recover prices very fast in absolute terms (in comparison with a similar rise in 10 year yields)

RBI Says Reserves are Fine; OMCs Will Pay Back

The RBI defended the rupee strongly, saying that it the situation was fine with the Oil Marketing Companies buying dollars from the market and that they have “enough” to pay back at least the first installment of the return of the swaps.

A reminder: Oil Companies were buying dollars directly from the RBI between August and November 2013. These were structured as swaps, with the OMCs having to return the dollars eventually. They have probably borrowed between $12 and $16 billion, which is my guess based on the fact that they need about $8 billion per month, and that RBI actually sold about $20 billion in total, in market sales and to OMCs, in the same period.

If the OMCs already have bought back about $6 to $8 billion in the market, which they will return to RBI before March 31, it eases the pressure on the rupee somewhat (otherwise these buys will come into the market now). The remaining $6-8 billion will hit the markets soon, but might not be a problem; it is of course entirely possible that RBI coordinated their own market sales recently with OMC purchases so that the market wouldn’t be impacted. We will never know; the RBI isn’t THAT transparent.

The rupee had eased off considerably, gaining from Rs. 63.2 to Rs. 62.14, before slipping back to Rs. 62.4 on Wednesday. Tomorrow will be the reaction to the Taper, and being an expiry date, the market will see pressures in both directions. Trade with care. (I wouldn’t write “cheap” options.)

Disclaimer

Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion.

Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.

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