Union Budget 2011-12; some thoughts

Here are some budget announcements (indented) with respect to the financial markets and some brief comments:

Foreign Institutional Investors
32. Currently, only FIIs and sub-accounts registered with the SEBI and NRIs are allowed to invest in mutual fund schemes. To liberalise the portfolio investment route, it has been decided to permit SEBI registered Mutual Funds to accept subscriptions from foreign investors who meet the KYC requirements for equity schemes. This would enable Indian Mutual Funds to have direct access to foreign investors and widen the class of foreign investors in Indian
equity market.

Comment: This will pave way for investments in equity MF schemes by foreign nationals/all other types of foreign investors which are either unregistered with SEBI or are not NRIs. This appears incremental, but could result in a substantial opening of the fund market to overseas investors including individuals who would like an exposure to Indian equities without the superfluous and painful registration process of an FII. This would also dilute (not eliminate because this is only for mutual funds rather than direct acquisition of equity) the SEBI regulation which permits foreign individuals to invest in Indian stocks by registering as a sub-account of an FII which requires a networth of the individual of US $ 50 million (and which the present proposed change does not).

Note: This announcement should follow with an amendment to Schedule 5 of the Foreign Exchange Management (Transfer or Issue of Security by a person resident outside India) Regulations, 2000. Currently, the aforesaid Schedule 5 only permits FIIs/Sub-Accounts/NRIs to invest in MF units. So only post an amendment notified by RBI to the above effect, the new proposal would become effective and till then the current policy would continue.

33. To enhance the flow of funds to the infrastructure sector, the FII limit for investment in corporate bonds, with residual maturity of over five years issued by companies in infrastructure sector, is being raised by an additional limit of US Dollar 20 billion taking the limit to US Dollar 25 billion. This will raise the total limit available to the FIIs for investment in corporate bonds to US Dollar 40 billion. Since most of the infrastructure companies are organised in the form of SPVs, FIIs would also be permitted to invest in unlisted bonds with a minimum lock-in period of three years. However, the FIIs will be allowed to trade amongst themselves during the lock-in period.

Comment: Besides development of the bond market and infrastructure institutions, there is also a possible unintended beneficiary of the original version of this reform viz. the yield curve. The yield curve is the graphic representation of returns of the risk free returns (govt. securities) - and without this curve, it is impossible to properly value corporate debt. India has never had a well formed yield curve because there are few govt. securities traded at the longer end of the spectrum and the seemingly highly liquid g-sec market is all concentrated in short term securities (see this piece). If the Nov 2010 circular pitching for longer term g-secs works, there could be a better yield curve (of course I am mixing the issuance market with the trading markets).