Limit for FII investment in govt, corporate bonds raised by $5 bn

Limit for FII investment in govt, corporate bonds raised by $5 bn

Mumbai: The government on Thursday raised the limit of investment by foreign institutional investors (FIIs) in the debt market by $5 billion (Rs 22,800 crore) each in government and corporate bonds.

The move will take the total that FIIs can hold in the debt market at any time to $30billion—$10 billion in government and $20 billion in corporate bonds.

The extra funds can only be invested in securities from infrastructure companies that have a minimum remaining maturity of five years.

This increase in limits will “help investment in infrastructure sector and the development of government securities and corporate bond markets in the country", the finance ministry said in a statement.

“The impact (of this announcement) on the government papers will be more visible than (on) the corporate bonds. Utilisation on the government side is lot higher than the corporate side. In fact, there is still some limit left in the corporate bond papers," said Ananth Narayan, head of rates, foreign exchange and credit (South Asia) at Standard Chartered Bank.

Bond dealers said restricting the extra investment to infrastructure-related firms and in papers with five-year residual maturity may not enthuse FIIs—who typically chase papers that expire within two years, not wanting to take longer-term interest rate risk in an emerging market with high inflation rate.

The head of a primary dealership said using FII money for infrastructure would not enthuse investors.

Primary dealers are firms that underwrite government bond issues, and must buy any papers that are unsold at the close of the auction.

“It will be all project-specific investment and FIIs have to evaluate the credit profile of the issuer closely. They would surely not like to take interest rate risk, market risk, credit risk and the high hedging cost for these bonds," said the FII debt manager, requesting anonymity because of the sensitivity of the issue.

“The pickup in investment will not be instantaneous but will take (a) very long time to take off. The high maturity profile will also deter FIIs to invest in government bonds," he said.

The last time the central bank raised the cap on foreign investment was in January 2009 when the global financial crisis had drained liquidity from Indian markets, leaving local institutions reluctant to lend to one another.

In late August, Mint had reported that government and the Reserve Bank of India (RBI) were considering hiking the limits. At the time, the RBI and a section of the finance ministry were concerned about the short-term investment profile of FIIs that could lead to arbitrage-induced volatility in the market.

According to both government and RBI estimates, India’s economic output is set to grow by at least 8.5% this fiscal. However, investment by both the government and the private sector is essential for the rate of growth.

The increase in FII limits comes at a time when this class of investors is aggressively buying Indian debt paper, which offers higher yields than that in many other countries. India also needs substantial foreign inflows to bridge a current account deficit, which, at close to 3%, is the highest since 1991.

FIIs have largely been equity investors in the 17 years since the country allowed their entry. However, the higher yield differential between Indian bonds and fixed income securities in the developed markets has induced FIIs to buy local debt paper worth $9.8 billion since January.

Close-to-zero percent interest rates in western markets allows investors to borrow in dollars and yens, and invest these in emerging markets such as India, where the benchmark 10-year paper offers a 7.90% return.

Together with investments in equity, FIIs have so far brought in a total of about $26.5 billion, the highest in any calendar year.

Helping the inflow is an increased risk appetite from investors for whom worries about the European debt crisis and US slowdown are fading.

The JPMorgan EMBI Plus Index, which measures the extra yield that investors demand to hold emerging market bonds over US treasuries, on Thursday stood at 290.26.

At the height of the Greek debt crisis in May, it had reached 354.7 basis points. One basis point is one-hundredth of a percentage point.

Allowing increased foreign investment could take some pressure off the local money market, where the government—looking to fund a fiscal deficit projected at 5.5% of gross domestic product—is jostling with companies that need to raise money to fund expansion.