Measuring outputs v. outcomes: Did the restriction on foreign investment in local debt achieve the intended outcome?

[The following guest post
is contributed by Anurag Dutt, Arpita
Pattanaik and Bhargavi Zaveri
, who are researchers at the Finance Research Group
at the Indira Gandhi Institute of Development Research, Mumbai.]
A good policymaking process requires significant
regulatory capacity. Before the policy is enacted, the State must (a) identify
a market failure and an appropriate intervention
to address it, (b) conduct a cost benefit analysis of the intervention, and
(c) conduct an effective public consultation where the public knows
about (a) and (b). Even after the policy is enacted, the policy by itself is
merely an ‘output’. After allowing for a reasonable lag for transmission, the
State must identify whether the intended outcome of the policy has been
achieved. For example, the intended outcome of the Insolvency and Bankruptcy
Code (IBC) is to improve the debt recovery rates in India. The IBC was enacted
in May 2016, and most of its provisions were notified in November 2016. The IBC
is an output. Allowing a medium term horizon for the impact to play out, an
impact assessment exercise will be due in November 2020 to assess whether the
debt recovery rates have improved. The impact on debt recovery rates would be
the outcome.
In the field of capital controls in India, we find
that State interventions are almost never accompanied with the steps mentioned
above (Burman and Zaveri (2016)). An ex-post impact assessment of interventions
in this field is unheard of. We wrote an article measuring the impact of a
regulatory intervention in February 2015, which banned Foreign Portfolio
Investors (FPIs) from investing in onshore bonds with a maturity period of less
than three years. Our findings of this research are summarised below.
The intervention
On 3 February 2015, the Reserve Bank of India (RBI) prohibited FPIs from investing in (a) debt
instruments with a maturity period of less than three years (such as corporate
bonds with less than 3 years maturity and commercial papers), and (b) money
market and liquid mutual fund schemes (as these schemes invested in corporate
debt with less than 3 years maturity). In this post, for ease of reading, we
call the onshore bonds with a maturity period of less than three years
“prohibited instruments”, and onshore bonds with a maturity period of
at least three years “permitted instruments”. The restriction was
effective from 4 February 2015. However, FPIs were allowed to continue holding
the prohibited instruments that they already held on 4 February 2015. Also, no
lock in period was imposed on instruments acquired by FPIs after the date of
the intervention, that is, FPIs could invest in and sell bonds with a maturity
period of at least three years, well before they matured.
The RBI circular did not specify what the market
failure was or what the intervention was intended to achieve, except that the
intervention was to bring consistency between the rules for FPI investment in
corporate bonds at par with FPI investment in Government securities. It was not
accompanied with a cost benefit analysis of the intervention, and it was not
preceded by a public consultation process. We are not aware if RBI or the
Central Government proposes to undertake an ex-post impact assessment of this
Due to the absence of a specific desired outcome in
the RBI circular, we relied on statements made by RBI to the press. These
statements, as well as our conversations with RBI employees on public forums
since the intervention, indicate that the intervention was intended to ‘nudge’
FPI investment in long-term debt in India. Our analysis is, therefore, limited
to the following questions:
1: Whether the regulatory intervention led to an increase in FPI investment in
the permitted instruments?
2: Whether the regulatory intervention led to any change in the behaviour of
FPIs in relation to the permitted instruments?
We use the daily holdings data from NSDL to identify
the kind of debt instruments held by FPIs from January 2014 until March 2016.
With this data, we identify the change between (a) the percentage of permitted
instruments held by FPIs during 12 months before the intervention; and (b) the
percentage of permitted instruments held by FPIs during 14 months after the
intervention. We take a long time-frame for the study, which helps in filtering
out the effect of other macroeconomic conditions and monetary policy changes
that could have caused short term fluctuations in FPI participation in the
Indian corporate debt market. Our findings, on the basis of this data and
methodology, are summarised below:
: We find that after the intervention, there is a marginal increase of
0.47% in the annual average FPI investment in the permitted instruments.
: We find that there is no change in the behaviour of FPIs in relation to
their holding of permitted instruments, before and after the intervention. From
anecdotal conversations with market participants, we know that FPIs do not hold
their local currency debt until maturity, especially where such debt is of a
long-term nature. We notice this finding even in our data. We observe that even
after the intervention, they continue to sell-off the permitted instruments
held by them shortly after listing.
An ex-post impact measurement exercise measures
whether an intervention has achieved the intended outcome. It helps analyse
whether any changes must be made to the intervention or the manner of its
implementation, to make it more effective. For example, if an ex-post impact
assessment of the IBC in 2020 shows that there has been no improvement in the
debt recovery rates in India, it should be a sufficient ground to re-visit the
design of the law. It is to facilitate such an exercise that the Indian
Financial Code drafted by the Justice Srikrishna-led Financial Sector
Legislative Reforms Commission requires every regulation to be reviewed three
years after its enactment.
Our ex-post impact analysis of the intervention of
restricting FPI investment in corporate debt with a maturity period of less
than three years finds no evidence of having achieved its intended outcome of
channelising foreign capital from the short to long end of the corporate bond
market. We find that neither do FPIs increase their participation in long term
bond holdings as a result of the intervention nor do they alter their behaviour
by holding the long term corporate debt securities until maturity.
We find that an attempt to centrally plan the allocation
of foreign capital inflows did not have the intended effect on at least one
occasion. On the other hand, the intervention withdrew foreign capital from the
most liquid part of the Indian debt market. Pandey and Zaveri (2016) show that
a substantial proportion of the bond issuances in similarly placed economies,
such as Indonesia and South Korea, belong to the maturity bracket of one-three
years. None of these economies prohibit foreign portfolio investment in local
currency debt of this maturity bracket. In India too, before the intervention
there was significant FPI interest in the bond market with a maturity profile
of less than three years. This is evident from the rapid utilisation of the
debt limits for CPs. The reason for this is simple. It is easier to price
currency and credit risk in debt of this maturity profile. For small to mid-sized
Indian companies which are not known to foreign investors, it is easier to
raise debt in this maturity profile from foreign investors. Globally, being
able to raise foreign debt in local currency is a boon for debtors, as the
currency risk is taken by the foreign investor. At a time when India is
struggling to set up its corporate bond market, the intervention has resulted
in depriving the relatively more liquid part of the market of significant
– Anurag Dutt, Arpita Pattanaik & Bhargavi Zaveri
Regulatory Responsiveness in India: A
normative and empirical framework for assessment
, Anirudh Burman
and Bhargavi Zaveri. IGIDR Working Paper IGIDR Working Paper WP-2016-025,
October 2016.
Radhika Pandey and Bhargavi Zaveri,
Time to inflate economy’s spare tyre, Business
Standard, 18 April 2016.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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