Measures to woo FIIs to buy government securities to strengthen the rupee have misfired. But FIIs have in fact made the rupee stronger—by pouring money into the equity market

The government’s landmark $10 billion auction of government securities (G-Secs) turned out to be a flop, despite strategic measures taken by the Reserve Bank of India (RBI) and the finance ministry to woo foreign investors. It is reported that the Securities Exchange Board of India (SEBI), which conducted the auction, saw investors buy government bonds worth only Rs20,469 crore, or 72% of the total offer of Rs28,496 crore. Volumes in corporate bonds were worse, where only Rs19,777 crore worth of bond permits were picked up, while Rs31,387 crore worth of bond permits were on offer.

The bond offer was designed to get FII money into India in order to strengthen the rupee which had hit a recent low of Rs57.135 against the US dollar.

However, the rupee has become stronger nevertheless and the reason for this is the sudden FII interest in Indian stocks. Following last Friday’s resolution of the European Union and the government making compromises on the General Anti-Avoidance Rules (GAAR), it renewed optimism and gave reasons for FIIs to relook at investing in India. The impact of the recent agreement to bail out troubled Spanish Cajas was hailed, but some FIIs saw that the deal was lacking in clarity and hence stayed away from European markets. Some even expect European markets to go down, hence were looking for alternative places to park their money. With the Indian government agreeing to relook into the GAAR provisions, FIIs welcomed the government intentions, after deferring it by a year. This renewed their hopes that the final outcome would be investor friendly. This made India an attractive destination vis-a-vis other economies, especially developed ones.

According to Bombay Stock Exchange (BSE) data, over the last five days, there has been a net inflow of Rs 4,895.95 crore into the Indian stock markets.

As for the bond market, rules were tightened with respect to the G-Secs being auctioned off. It is believed that this batch G-Secs, which are being auctioned, once purchased cannot be reinvested, posing a dilemma for investors interested in the bond buying programme. In earlier programmes the bonds could be reinvested, but not this time. With macro-economic risks prevailing, the FIIs weren’t interested in being locked and unable to sell if things go bad.

Last month, Pranab Mukherjee, just before resigning to become a presidential candidate, in conjunction with the RBI, raised the limit for investment by FIIs in government securities (G-Secs) by $5 billion to $20 billion, hoping that FIIs would bite the bait and buy its higher yielding bonds, which offer higher returns than most developed and emerging markets, including the US. The government, especially the RBI, also hoped that this would help the floundering rupee and stabilise it.

In a press release, RBI said that, “Existing limit for investment by foreign institutional investors in G-Secs has been enhanced by $5 billion. This would take the overall limit for FII investment in G-Secs from $15 billion to $20 billion. The sub-limit of $10 billion (existing $5 billion with residual maturity of five years and additional limit of $5 billion) would have the residual maturity of three years.”

At time of writing this article, the US$-Re was seen at the Rs55/$ threshold. While the auction hasn’t worked as planned, which was to resurrect the rupee, equities came to the fore and supported the currency. Talk of unintended consequences. If only Mr Mukherjee made some sensible noises about reforms, he would not have to come with the G-Sec plan.