New Delhi/Mumbai: The finance ministry on Thursday initiated action to allow freer flow of foreign investment into the domestic debt markets, and indicated that it was considering letting foreign retail investors buy Indian stocks directly. At present, foreign retail investors are allowed to invest only through mutual funds.
The ministry raised the ceilings for investment by foreign institutional investors (FIIs) in corporate and government bonds by $5 billion in each category.
The move could potentially increase inflows of foreign funds, easing pressure on the Indian rupee, which dipped below Rs 51 against the dollar in intraday trading on Wednesday, and inject fresh money into a market strapped for capital. The local currency has depreciated nearly 13.5% from its fiscal year high in July.
FIIs have been net sellers in both equity and debt in the current fiscal year by $1.23 billion and $2.2 billion, respectively.
Reserve Bank of India deputy governor Subir Gokarn said in an interview with CNBC-TV18 that the expanded debt investment limits would offset foreign fund exits from other channels. Any increased inflows will create “a positive impact at least in terms of reversing the depreciation” of the rupee, he said.
While FIIs can now invest up to $15 billion in government securities, they can buy up to $20 billion of corporate bonds. The limit for FII investment in long-term corporate infrastructure bonds has been kept unchanged at $25 billion. Thus, the total FII investment limit in the Indian debt market has been raised from $50 billion to $60 billion.
The finance ministry, in a statement, said that as of 31 October, against a ceiling of Rs 43,650 crore in government securities, FIIs had invested Rs 41,253 crore. Similarly, against a ceiling of Rs 74,416 crore in corporate bonds, FIIs had invested Rs 68,289 crore.
“In view of this, there is little space available for further FII investments in government securities and corporate bond markets,” the statement said.
However, against the ceiling of Rs 112,095 crore for infrastructure bonds, FII investment of only Rs 28,370 crore had been made by 31 October.
Out of the present limit of $10 billion on government bonds, FIIs have to invest $5 billion in bonds with a residual maturity of five years. However, the relaxation in ceiling on Thursday has no such obligation.
“The policy has been reviewed in the context of India’s evolving macroeconomic situation, the need for enhancing capital flows and making available additional financial resources for India’s corporate sector,” the finance ministry said. “The present enhancements would increase investments in debt securities and help in further development of the government securities and the corporate bond markets in the country.”
Gokarn cautioned there are risks that come with the move.
“We should be conscious of the risk that more debt exposure means more vulnerability overall. But for the moment the benefits seem to have outweighed the risk,” he said.
The strain on FII inflows into the equity market is not India-specific and more a result of global uncertainties, said Thomas Mathew, joint secretary in charge of the finance ministry’s capital market division.
Asked whether allowing higher fund flows through the FII route into the debt market will check further rupee depreciation, Mathew told reporters: “We’re not raising the ceilings for that purpose. But it’ll help.”
Bond dealers say the move will generate considerable interest in FIIs towards the government bond segment, but given the rupee’s weakness, they may wait longer.
“The present currency weakness will limit the FII interest for a while but when the currency view turns, over a period of time, FIIs will show interest in the (higher investment) limits. That way they stand to earn high yields and also get some currency gains when rupee appreciates,” said B. Prasanna, managing director and chief executive officer of ICICI Securities Primary Dealership Ltd, a bond trading house.
Analysts said the move will help address the liquidity situation in the system.
“The system liquidity is drying up, bond yields are rising and a bond auction has been cancelled. It is time that the government or RBI...do something to stabilize the market. By increasing the limits and announcing open market operations, they’re doing precisely that,” said Joydeep Sen, senior vice-president, advisory, for fixed income, at BNP Paribas in Mumbai.
The banking system is also liquidity-starved. The liquidity shortage in the banking system has been more than Rs 1 trillion in the last few days. To help shore up liquidity in the system, RBI on Wednesday said it will buy Rs 10,000 crore worth of bonds from the secondary market through its open market operation.
Corporate bonds, too, stand to benefit over time. FIIs usually don’t finish their limits on corporate bonds because the market is not liquid, said a bond dealer with a foreign bank, who did not want to be named.
This will increase the flow and broadbase investors in India’s bond market, making it deeper, said Prasanna.
“India is fundamentally better than what the rating agencies may portray through their sovereign ratings. Investors are aware of that and thus they will likely be reasonably enthused to have higher limits in bonds,” said Sen.
According to bond dealers, FIIs would like to invest in shorter-term maturities as the returns in the shorter tenure are also close to what the 10-year bonds are offering. For example, the yield on the six-year government paper is now at 8.76%.
Mathew said that the finance ministry is seriously considering allowing qualified foreign investors (QFIs), or foreign retail investors, to invest directly in the equity markets to meet demand from stakeholders. Refusing to set a timeline for such a decision, he said no ceiling will be set for such retail investments.
At present, high networth individuals, who have a minimum networth of $50 million, can invest in the equity markets by opening a sub-account with a registered FII in India. In August this year, the ministry allowed QFIs to invest in mutual funds directly up to $13 billion. Of the total amount, $10 billion is for equity-based funds and the rest for debt funds in the infrastructure sector.
On raising the limit of external commercial borrowings (ECBs), Mathew said the ECB limit will not be a constraint for corporate borrowing. Against a ceiling of $30 billion, Indian companies have borrowed $20.77 billion overseas till the end of October.