FIIs may cash out from debt & equity

MUMBAI: Global ratings agency Fitch���s review of India���s local currency rating outlook could see withdrawal of funds by foreign institutional investors, both from equity and debt markets. The move could also cause a spike in yields on short-term instruments such as commercial papers (CPs) and certificates of deposits (CDs), making it costlier for banks and corporates to raise short-term funds.

On Tuesday, global ratings agency Fitch revised the outlook on India���s long-term local currency issuer default rating to negative from stable, driven by the slippages on the central government���s fiscal position. The agency has also taken note of the rise in the money that the Centre would need to raise by issuing bonds to fund subsidies which the Union Budget has not provided for.

According to a senior treasury manager, most FIIs had already started exiting from the equity and debt markets in anticipation of such developments. They said the impact would be felt more severely on the equity markets than in bonds.

Standard Chartered Bank director & regional head for South Asia Prakash Subramaniam said: ���Investors would certainly adopt a more cautious stance while investing in the Indian market. As such, markets are witnessing tight cash conditions and such a move would see credit spreads rising by more than 50 basis points.��� A trader associated with a primary dealer said several foreign portfolio investors (FIIs) follow strict investment norms, which prevent them from investing in countries assigned a speculative grade. This means FIIs in India would now look at either slowing down their investments. Some of their could even consider a complete pullout, going forward, he said.

The rating move is also likely to impact the local currency market. A senior dealer in the local bond market pointed out that in such a scenario, there could be more FIIs pulling out dollars and pushing the rupee to 44-levels.

Said a senior fund manager with a leading asset management firm: ���In such situations, a rate hike by the central bank will be absolutely essential to prevent a run on the local currency. Otherwise, it will give rise to a situation like in South Korea where rates have not been allowed to rise and the currency has been constantly deteriorating.���

Most traders in the local bond market are of the opinion that this was a much-expected move by Fitch, considering that the central government finances were under the scanner for a host of reasons. These include the rising fiscal deficit positions and the recent issue of large amounts of oil bonds apart from the manner in which the government was managing finances. ���FIIs don���t look to rating agencies to show them the way. Markets work ahead of rating agencies. The reasons that Fitch has highlighted were all there two-three months ago. What it does do in a bad market is compound fear. Henceforth, it would be tough to borrow abroad,��� said the research head of a leading FII.