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Radhika Menon

Mumbai, Aug. 10 Rising bond yields and more flexible regulations have paved the way for the return of foreign institutional investors (FIIs) to the Indian debt market.

FIIs, who were nearly absent from the debt market for most part of the year, have stepped up investments in July. According to SEBI data, FIIs invested around $897 million in the debt market in July, while in March, April, May and June, their investments have been negative. FIIs’ outflows between March and June were around $928 million.

FIIs had, however, started off the year on a positive note by investing $484 million and $619 million in January and February, respectively. The FIIs are now seeing a significant arbitrage opportunity in debt investment.

“While the one-year Mumbai Interbank Forward Rate is 7 to 8 per cent, the yield on a one-year treasury bill is 9.25 to 9.5 per cent and a AAA-rated corporate bond earns a yield of 10 to 10.5 per cent. So there is a substantial arbitrage opportunity of at least 2 percentage points,” said the head of fixed income and capital markets at a foreign bank.

Between March and June, yields were lower and forex hedging costs in terms of forward premia were also higher, added the official.

“Since it is dollar denominated investment, the arithmetic, as far as returns are concerned, was not working out. FIIs were in fact looking at offshore Indian credit instruments such as FCCBs (foreign currency convertible bonds), where the credit spreads were wide and there was no foreign exchange risk,” said the treasury head at a foreign bank.

SEBI has also made it easier for FIIs to invest in the debt market.

In July, SEBI introduced a circular that granted up to five business days for the “replacement of disposed of/matured debt instrument/position”.

“A number of FIIs, who had sold their bonds and wished to buy again, had to apply for fresh limits from SEBI. The stock market regulator has now given FIIs the leeway to buy back bonds within five days, which has made it easier for them,” said a senior treasury official at a foreign bank.

Recently, the Government had also increased the cumulative debt investment limits by FIIs from $3.2 billion to $5 billion and from $1.5 billion to $3 billion for investments in government securities and corporate debt, respectively.

In 2007, FIIs invested $2.30 billion in debt and market participants believe that in 2008 the higher limits should invite more investment interest from FIIs.

More Stories on : Debt Market | Foreign Institutional Investors

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