Foreign investors have pulled out a staggering Rs 50,600 crore (about USD 8.5 billion) from the Indian debt market in just over two months amid lack of clarity over tax norms for returns on such investments.
Weakness in the Indian currency has also been a factor in outflows, as the rising cost of hedging a volatile rupee hurts the yields for FIIs.
Since June this year, Foreign Institutional Investors have withdrawn Rs 50,599 crore from the debt market, according to data available with Sebi.
Prior to this, overseas investors made net inflow of close to Rs 25,000 crore in the first five months of 2013.
Many FIIs are holding back their investments in Indian debentures due to lack of clarity on whether such instruments would attract lower withholding tax allowed by the government in May for bonds.
"Large overseas institutional investors who are registered as FIIs are looking to invest in the debt segment, but one burning issue that these investors face is regarding the tax on the interest earned," PwC Executive Director (Financial Services) Suresh Swamy said.
To attract greater participation in debt securities by foreign investors and accelerate the pace of economic growth, the government in May reduced the withholding tax on interest earned on bonds to 5 per cent from 20 per cent.
"However, it is unclear whether debentures are eligible for the lower withholding. Only bonds seem to have been covered. This is resulting in holding back of investments in Indian debt," he added.
Although the market uses the terms bonds and debentures interchangeably, it seems that FIIs do not want to take a chance and avoid confusion about taxation at a later stage, experts said.
Meanwhile, the rupee has been consistently hitting record lows and it slumped to a life-time low of 61.80 (intra-day) against the US dollar on August 6. Since April 30, the rupee has depreciated by around 14 per cent.
Indian debt markets had witnessed robust interest from FIIs last year as well, when their net investments stood at close to Rs 35,000 crore.
So far this year, foreign investors have pulled out a net over Rs 26,000 crore (USD 4 billion) from the debt market.