The Reserve Bank of India (RBI) has revised its rules for investments by foreign portfolio investors (FPIs) in Indian bonds, including reduction of residual maturity, withdrawal of the auction mechanism and revision of the cap on aggregate FPI investments in a single security. The new measures will boost foreign fund flows into Indian debt and cool off the borrowing costs at a time when yields are on an upward trajectory, having pared all gains made in the first few weeks of April.
The central bank has withdrawn the minimum residual maturity required by FPIs to invest in central government securities and state development loans, subject to a condition that investment in securities with residual maturity below one year should not exceed 20% of the total investment of that FPI in that category. So far, FPIs were required to invest in G-secs with a minimum residual maturity of three years.
For corporate bonds, FPIs are permitted to invest in papers with minimum residual maturity of above one year. The step is likely to bring in considerable foreign fund flows into short-tenor paper—arguably an attractive segment for foreign investors.
The central bank has also revised the cap on aggregate FPI investments in any central government security to 30% of the outstanding stock of that security from 20%.
One of the noteworthy changes is the scrapping of the auction mechanism, wherein FPIs were required to purchase investment limits once the limit utilisation breached 90% of the permitted quota.
“With Clearing Corporation of India Ltd (CCIL) commencing online monitoring of utilisation of G-sec limits, it has been decided to discontinue the auction mechanism with effect from June 1, 2018. Utilisation of FPI limits shall be monitored online thereafter,” the RBI stated.
Although FPIs only paid a negligible amount to purchase these limits, what matters here is the fact that foreign investors will not have to worry about participating in the limit auctions to accumulate limits even during times when their preference would be to wait for the release of an important economic data before making investment decisions.
The central bank has also harmonised the all-in-cost ceiling for external commercial borrowings over the benchmark rate. While the all-in-cost ceiling ranged from 300 to 500 basis points for different maturities and different track classifications earlier, the central bank has mandated a uniform ceiling of 450 basis points over the benchmark rate. The benchmark would be six-month USD LIBOR (or applicable benchmark for respective currency) for Track I and Track II, while it will be prevailing yield of the Government of India securities of corresponding maturity for Track III (Rupee ECBs) and RDBs.
It is noteworthy that some firms with lower ratings often faced higher demand for yields from investors that took the overall borrowing cost above the stipulated all-in-cost ceiling. As a result, these firms became ineligible for ECB funding. The revised ceiling is positive news for those companies that were finding it hard to get three-five year ECB funding under track-1 where the all-in-cost ceiling was at 300 bps over the benchmark.