India's pursuit of global investors hits turbulence

By Marc Jones and Saikat Chatterjee
LONDON (Reuters) - India's drive to lure more foreign money into its financial markets is once again being dashed after it has only made progress after years of talking but little action.
Deadly clashes between Indian and Chinese troops on the Himalayan border, an increase in coronavirus cases and the second credit rating cut of the month on Thursday have put the country back in the international spotlight this week.
It is an unfortunate time that comes just a few months after a new effort by Indian policymakers to open up the country's bond markets to global investors, but complements a list of stacking issues.
After years of rapid growth, India's economy is facing the worst recession in recent history, unemployment has been catapulted to an unprecedented 24%, and additional government spending is expected to leave a yawning budget deficit of 11%, which will weigh on debt to GDP ratios above 80% .
"The coronavirus pandemic has significantly weakened India's growth prospects this year and exposed the challenges associated with high levels of government debt," said rating agency Fitch, when it partnered with Moody's to lower the country's rating.
The moves are swaying at the last level of investment grade and a possible return to junk status for the first time in nearly 14 years. Fitch raised doubts as to whether 6-7% growth rates could be reclaimed, while Moody's general concern is that the remedial measures needed to strengthen fiscal health have barely started.
Mark Evans, investment analyst for emerging market debt and currencies at Ninety One, said another downgrade would "likely trigger a jerky negative response to all Indian assets".
Brazil and South Africa have shown the cost of losing your investment grade strips in recent years. However, Evans added whether there was a willingness and ability to put the fundamentals back on a solid footing.
"The coronavirus pandemic is a global shock and is not unique to India," Sanjeev Sanyal, chief financial advisor to the Treasury Department in New Delhi, told Reuters in response to questions about rating concerns.
"In terms of our ability to service foreign debt, India's foreign exchange reserves of $ 500 billion and the increase are more than sufficient to meet all our foreign obligations."
India's investment grade status is under threat
Question of timing
Policy makers have been talking about opening the Indian financial sector and internationalizing the use of the rupee with little progress for more than a decade.
One element of the recent reform plans has been to bring foreign investors to Indian markets, as China has done in the past decade.
World Bank chief David Malpass has found that India's equity market cap has risen to over $ 2.2 trillion, but the debt market is still in a "developing stage".
According to Sergi Lanau, deputy chief economist at the Institute of International Finance (IIF), less than 4% of government bonds are held by foreigners, compared to 20 to 40% in nearby Indonesia and Malaysia. Corporate bond issuance was around 4% of GDP, which is also much less than in other major emerging markets.
In March, the central bank made its first real attempt to remedy this by moving away from 6% of the restrictions on foreign government bond holdings and granting full access to a select group of benchmarks under the Fully Accessible Route (FAR) plan .
The previous limits kept India's bonds away from the world's leading investment indices, such as JPMorgan's GBI-EM or Bloomberg Barclays Global Aggregate, which attract money managers targeting emerging markets worldwide.
Given the FAR changes, JPMorgan has identified India this month as one of four countries vying for a possible inclusion of GBI-EM. The index could have a chunky weighting of 7.8%, although the US bank no longer indicated that this was imminent with only 9% of the debt currently covered by the new regulations.
Jayesh Mehta, Treasurer of the Indian country at Bank of America, is optimistic that at least one of the major indices will soon start, although others believe it is still a long way off. The Barclays Bloomberg Index also requires an investment grade rating.
Aviva fund manager Stuart Ritson is one of the doubters. He believes the prospect of further rate cuts by the Reserve Bank of India is still making the country's bonds attractive. Foreign investors sold $ 14 billion this year. Indian equity outflows also reached a three-year high in the March quarter.
BofA's Mehta also sees little progress in making the rupee a global power currency. Masala bonds - rupee bonds issued outside of India - have emerged, but there is little incentive for companies to settle internationally in the currency.
The rupee's share of daily foreign exchange market turnover has gradually increased to 1.7%, but compared to 4.3% for China's yuan, where Beijing was more proactive, it is pushing for yuan bonds.
BIS market share graph
New Delhi's reluctance to issue US dollar-denominated bonds could also limit government options at a time when a gaping budget gap needs to be filled. Downgrading the ratings would only make the job more difficult.
"Given the scale of the shock to the system we are seeing now, we definitely need to monitor this area," said Neeraj Seth, head of Asian credit at BlackRock.
India flows
(Additional reporting by Manoj Kumar in New Delhi and Swati Shetye Bhat in Mumbai; editing by Toby Chopra)

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