Given the sharp spike in bond yields over the past several months and the fact the borrowing calendar for 2018-19 is not a particularly light one, it is not surprising the investment conditions for foreign portfolio investors (FPIs) have been eased.
Given the sharp spike in bond yields over the past several months and the fact the borrowing calendar for 2018-19 is not a particularly light one, it is not surprising the investment conditions for foreign portfolio investors (FPIs) have been eased. At a time when the central government is planning a net mop-up of Rs 3.9 lakh crore for FY19 and the states are also expected to be big borrowers, RBI wants to try and stoke demand. Bond yields rose 43bps in just the last month and unless some additional demand comes into the market, it would be difficult to keep yields in check. While the overall investment limits haven’t been raised, RBI has thrown in a few sweeteners for FPIs.
This is necessary since public sector banks, the biggest investors in the G-Sec market, have been shying away from investing in G-Secs. For one, they have incurred big losses on their bond portfolios thanks to the sharp rise in yields and, moreover, the rate of growth in deposits has been remarkably slow at a time when demand for credit has been picking up. While deposits have been growing at 5-6%, the pace of loan growth has been a faster 8-11%, and a clutch of banks has upped interest rates on deposits over the past month. A part of the uptick in credit has been attributed to the shift in demand from LoU-related credit overseas to local loans following the ban on LoUs by RBI. Indeed, RBI cancelled several auctions of G-Secs because state-owned banks showed little interest; one recent action attracted just about 50% of the amount RBI wanted to sell that day.
It is no secret that FPI debt funds prefer bonds of a shorter maturity because it is easier to hold them till maturity and spare themselves a loss. However, RBI feared that allowing FPIs to invest in short-term paper might lead to volatility—as money moved in and out—and so mandated a three-year residual maturity. That has now been lifted and FPIs can buy paper with any residual maturity. However, a single FPI cannot own more than 20% of its total investment in a particular government security with a residual maturity of less than one year. For corporate bonds, however, the residual maturity must be more than one year. Abandoning the auction mechanism and offering FPIs securities on tap is also a good idea since it gives them a choice of entry points which is only fair. Again, the cap on aggregate FPI investments in any particular G-Sec which was earlier 20% has now been raised to 30%; this means FPIs can own more of the popular G-Secs.
RBI has also made it easier for companies that are not rated too highly to borrow overseas. The all-in cost ceiling for an external commercial borrowing (ECB) has been altered to 450bps over the relevant benchmark for all maturities; earlier, the ceiling was different for different maturities. For companies with a relatively low rating, the all-in cost ceiling was earlier 300bps, but with the ceiling having been raised, they should find it easier to attract investors by offering a higher coupon.
In other words, more junk bonds are likely to hit the market. While $23 billion worth of FPI came into the bond markets in 2017, $6.5 billion flowed out in 2016. Given that yields on Indian paper remain far higher than those in the developed world, foreign funds should find Indian paper attractive, especially now that the rules have been relaxed.