RBI to open up FPI limits in debt in phases4 min read . Updated: 30 Sep 2015, 02:27 AM IST
Limits will be hiked every six months; central bank allows foreign investment in state bonds
Mumbai: The Reserve Bank of India (RBI) will increase the foreign investment limit in central government securities to 5% of the outstanding stock of such securities by March 2018, the central bank said as part of its bimonthly monetary policy on Tuesday. Foreign investors will also be allowed to invest in state government bonds, which was so far not permitted.
This is the first time that the central bank is setting out a formal medium-term framework for foreign investments in government bonds. A gradual increase in foreign investment in government bonds will give RBI space to bring down the mandated bond investments (the statutory liquidity ratio, or SLR) of Indian banks, which is currently at 21.5%.
“The limits for FPI (foreign portfolio investor) investment in central government securities will be increased in phases to 5% of the outstanding stock by March 2018. In aggregate terms, this is expected to open up room for additional investment of ₹ 1,200 billion ( ₹ 1.2 trillion) in the limit for central government securities by March 2018, over and above the existing limit of ₹ 1,535 billion ( ₹ 1.535 trillion) for all government securities (G-secs)," RBI said.
So far, RBI had put in place a limit of $30 billion for foreign investments in government bonds, which has been completely used up, according to data available on the National Securities Depository Ltd (NSDL) website.
Limits will be hiked every six months. For the current fiscal year, limits will be increased on 12 October 2015 and 1 January 2016 by ₹ 13,000 crore each. ₹ 7,500 crore of this increase in limit would be reserved for long-term investors and the remaining ₹ 5,500 crore for others.
“Earlier, opening up on a piecemeal basis meant that existing investors used to absorb the enhanced limit, but now, long-term investors can plan properly and take positions when auctions happen. Long-term investors take positions for currency diversification and they wanted RBI to open up limits on a more substantial and predictable basis," said Jayesh Mehta, head of treasury at Bank of America Merrill Lynch. Mehta added that long-term foreign investors act as “absorbers" and prevent volatility in the market.
RBI will also open up the state government bond market to foreign investors for the first time. “...there will be a separate limit for investment by FPIs in state development loans (SDLs), to be increased in phases to reach 2% of the outstanding stock by March 2018. This would amount to an additional limit of about ₹ 500 billion ( ₹ 50,000 crore) by March 2018," said RBI in its statement.
A ₹ 3,500 crore limit for foreign investment in SDLs would be opened up in October and a similar amount in January 2016.
According to Mehta, the increase in the limits together will mean that foreign investors can invest an additional ₹ 1.7 trillion in central and state government securities by March 2018, which will double the amount ( ₹ 1.5 trillion currently) that foreign investors can invest in government securities.
The existing requirement of investments being made in G-secs with a minimum residual maturity of three years will continue to apply.
Separately, RBI specified that Indian companies will be allowed to issue rupee-denominated bonds in overseas locations within the $51 billion limit set for foreign investment in corporate bonds. Such bonds can be issued with a minimum maturity of five years.
“There shall be no restriction on the end use of funds except a small negative list," said RBI, adding that detailed instructions will be issued separately. The amount of withholding tax imposed on the issue of such securities will be a crucial factor in determining their success.
Allowing greater foreign participation in the government bond market will help create a new pool of money to compensate for a gradual lowering of SLR requirements imposed on banks. In its policy statement, RBI said it intends to bring down SLR by 25 basis points every quarter till March 2017.
A basis point is one-hundredth of a percentage point.
Banks, however, have been holding SLR securities far in excess of the current limit of 21.5% due to weak credit demand. Should credit growth pick up, banks will get more leeway to lend out this additional capital.
“I think the increase in FPI limits is a welcome step because, in a way, it is opening up a larger source of funds. As far as banks’ holding of excess SLR is concerned, that also partly depends on how credit demand picks up," said Chanda Kochhar, managing director and chief executive officer at ICICI Bank Ltd.
“Fundamentally, it is the right step to promote bond markets. Obviously, you need the credit enhancements because the investors are most likely to have higher limits for higher rated bonds. This is a good effort to develop the bond market," said Aditya Puri, managing director of HDFC Bank Ltd.
India’s sovereign bonds rallied, pushing the 10-year yield to a 26-month low, after the central bank cut interest rates more than expected and eased curbs on foreign ownership of debt. The yield on government bonds due May 2025 slumped 12 basis points to close at 7.61%. Yields traded in the range of 7.74 on the higher side and 7.57 on the lower side. Bond prices and yields move in opposite directions.