MUMBAI May 2 India's move this week to slash
tax on interest income that foreigners pay on local bonds, its
most significant measure to boost the debt market in recent
years, could draw several billion dollars in investment and
provide support for the rupee.
Foreign investors have long complained about the high tax
they pay on their earnings on Indian debt. Other Asian countries
like Singapore and Malaysia charge little or no such tax.
Finance Minister P. Chidambaram on Tuesday lowered the
withholding tax on rupee-denominated government and corporate
debt to 5 percent from 20 percent for two years starting in
The move, part of an effort to boost inflows as India
grapples with a record current account deficit, follows investor
presentations last month by Chidambaram in the United States and
"This has been a long-standing ask of FIIs (foreign
institutional investors) and is a very welcome step," said
Hitendra Dave, head of global markets at HSBC India in Mumbai.
Over time, the tax cut could draw an additional $18 billion
in inflows, figures Samiran Chakraborty, chief economist at
Standard Chartered Bank in Mumbai.
Earlier this year, New Delhi scrapped cumbersome limits on
debt, such as residual maturity requirements, in a bid to
attract longer-term investors like sovereign wealth funds.
The government's move would result in a roughly 100 basis
points increase in after-tax government bond yields and comes as
Japan's massive stimulus has led to more inflows into regional
bond markets, lifting bonds and the rupee.
Nearly 95 percent of the $25 billion limit for foreigners in
government debt has been exhausted, while 45 percent of the
corporate debt limit of $51 billion has been used, as per
capital market regulator data covering until end-April.
Nearly $2 billion has entered India's debt market since
Barclays Capital expects government bonds to give returns of
6.2 percent, unhedged for forex exposure, over a three-month
horizon as yields drop 35-40 basis points over the next three
months, prompted by monetary easing.
The Reserve Bank of India is widely expected to cut its
policy repo rate by 25 basis points on Friday.
The reduction in withholding tax will support the rupee at a
time when sentiment is positive after the recent slump in global
"Along with the anticipated pick-up in FDI, this may
perceptibly ease India's balance of payments situation, if all
the potential inflows are realised," Standard Chartered analysts
wrote in a note. The bank now says the rupee may end stronger
than its forecast of 55 to the dollar by end-June.
The rupee hit a two-month high of 53.6625 on Thursday,
helped by hopes for more inflows fuelled by the tax cut. Bond
yields fell as much as 8 basis points to 7.68 percent, a
Analysts expect the government to further raise government
bond limits once the current levels are utilised.
"Moves in this direction should be considered carefully
given the need for stable yields ahead of another sizeable
market borrowing program this year," said Radhika Rao, economist
at DBS in Singapore.
(Additional reporting by Archana Narayanan; Editing by Tony
Munroe and Simon Cameron-Moore)