MUMBAI - India's move to ease restrictions for foreign investors in domestic debt markets is unlikely to significantly boost capital inflows unless the government also cuts withholding taxes, a more difficult decision for a country with fiscal challenges.
Government bonds gained mildly after India removed some of the restrictions on debt purchases by foreign institutional investors (FIIs) on Saturday.
The government had already taken other measures to attract capital flows such as simplifying the "Know Your Customer"registration rules for overseas investors after Finance Minister P. Chidambaram met FIIs during a trip abroad in January.
But analysts said the key stumbling block in attracting foreign investment remained a withholding tax of up to 20 per cent on the interest paid on India debt.
"We think this is clearly a step forward in easing the rules for FIIs in debt markets, and combined with recent easing of Know Your Client norms, it may at the margin be positive for bonds, particularly for corporates," Barclays Capital said in a note on Monday. "However, the regulation falls short of market expectations of lower withholding tax on government bonds."
Under the new rules, India will create two broad categories of debt: Foreign investors can invest up to US$25 billion (S$31 billion) in government bonds, including both long- and short-term debt such as treasury bills, and up to US$51 billion in corporate bonds.
That removes separate limits on different types of debt, doing away with a complicated system of categories for debt and restrictions on which types of investors can bid for the debt.
The move should especially benefit corporate bonds, where total foreign investment, including in infrastructure, was estimated at about US$21-US$22 billion, well below limits.