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MUMBAI (Reuters) - India's auction of quotas allowing foreign investors to buy bonds attracted solid demand, reflecting expectations that the central bank will cut interest rates and that the government will deliver a fiscally disciplined budget.
The strong demand signals foreign investors anticipate a rally in debt this year, which could prove a boon for India given its need for capital inflows to narrow a current account deficit that hit a record high in the July-September quarter.
The auction is the last before the 2013/14 budget to be unveiled on February 28 as well as a central bank policy review in mid-March, and comes after India recently raised the amount of corporate and government debt that foreign investors can buy.
"Bonds are promising attractive returns on expectations of more OMOs, rate cuts, and as the government is seen pushing through new policies to improve the investment climate," said Ajay Manglunia, senior vice-president of Edelweiss Securities referring to bond purchases via open market operations.
India attracted 781.77 billion rupees worth of orders for its so-called debt auction limits, which gives foreign investors the right to invest in debt up to the limit bought.
The amount of orders received was above the 666 billion rupees on offer for different categories of government and corporate debt.
India restricts foreign access to its debt markets because of its reluctance to owe money to overseas investors, and has a complicated system of categories that divide up bonds into maturities and restricts which types of investors can bid for the debt.
As is usually the case, quotas for government and corporate bonds that offer relatively fewer restrictions attracted the strongest demand.
India's benchmark 10-year bond yields have dropped 23 basis points since start of this calendar year on growing hopes that the government will deliver a fiscally disciplined budget that averts a damaging sovereign ratings downgrade.
Finance Minister P. Chidambaram has pledged to meet a fiscal deficit target of 5.3 percent of gross domestic product for the financial year ending in March and a target of 4.8 percent for fiscal 2013/14.
The government has also followed through with unpopular fiscal measures, including allowing state retailers to raise susbsidised diesel prices and slashing spending.
Just this week, the government on Monday cancelled its last bond sale worth 120 billion rupees for the current fiscal year, scheduled this week citing a build up in cash balances.
Expectations that the Reserve Bank of India will cut interest rates and buy bonds to ease a cash crunch in the banking system have also supported bond prices.
The RBI cut India's key lending rate by 25 basis points last month, and despite a cautious tone, analysts widely expect the central bank to ease by an additional 75 to 100 bps during 2013.
Overseas investors held 2.7 percent of government bonds at the end of 2012, according to regulatory data.
The Securities and Exchange Board of India (SEBI) conducts auctions of debt limits to overseas investors on 20th of every month.
Net foreign inflows reached $6.6 billion in 2012 and $706.50 mln so far this year.
Because of the strong demand, the government has eased some of its restrictions against foreign investors, including raising limits in government and corporate bonds by $5 billion each in January.
With the increased limits, the government bond quota for foreign investors stands at $25 billion, and at $50 billion across corporate bonds.
Reporting by Archana Narayanan; Editing by Sanjeev Miglani