In consultation with the government and SEBI, the RBI announced the much-awaited revision in the FPI limits for the bond markets, vide its circular dated April 6, 2018. It chose to continue with its calibrated approach towards opening-up of the Indian bond markets to FPIs, despite market expectations of a more liberal approach this time around.

What has changed

The RBI has increased the limit for FPI investment in Central government securities (G-secs) by 0.5 per cent to 5.5 per cent of outstanding stock of securities for 2018-19, and further to 6 per cent of outstanding stock of securities for 2019-20, while retaining the limits in State Development Loans (SDLs) at 2 per cent of the outstanding stock of securities.

At the same time, the overall limit for FPI investment in corporate bonds has been fixed at 9 per cent of the estimated stock of corporate bonds outstanding as on March 2019.

Although the hikes in limits seem rather nominal, the tweaks to the sub-limits enhance the overall impact of the revised regulations. With lower utilisation in the various sub-limits for FPI investments, the RBI has increased the allocation for general investors in G-secs and moved a part of the allotment for long-term investors in SDL to the G-sec category.

In the corporate bond segment, the RBI has completely done away with the sub-segments and combined them into a single limit for FPI investment in all types of corporate bonds.

The discontinuation of sub-categories such as infrastructure bonds and merging them into a single limit, provides greater flexibility to both issuers and FPI investors. As the utilisation level in the sub-limits for the infrastructure segment was low, the actual increase in the FPI limits can be construed to be appreciably higher than what has been announced.

We believe this measure of merging sub-limits in corporate bonds would increase the limits to the general FPIs by 28 per cent, as against a perceived overall increase of just 18 per cent for general corporate bonds.

Since the Indian banking system is still facing challenges to support credit off-take, a higher FPI limit should help stronger entities tap alternative sources of funds at attractive rates.

Outlook

The hike in FPI limits was somewhat lower than market expectations. As inter-linkages with global economies increase, the RBI is clearly in no rush, and is quite comfortable with a gradual opening of the FPI limits, a strategy that has so far proven effective for India.

The hike in FPI limits was expected to have a cooling-down effect on bond yields. However, banks have been net sellers of government bonds in the current month, affecting the demand-supply dynamics.

At the same time, the indicative calendar of market borrowings by State governments has showed a sharp rise in their planned gross issuance to ₹1.16-1.28 trillion in the first quarter of this fiscal from ₹0.65 trillion in the same quarter last fiscal. Also, flaring up of geopolitical risks and the spike in crude oil prices, have unexpectedly pushed up yields in the last week.

This has reversed the cooling that had taken place following the regulatory dispensation on amortising the mark-to-market (MTM) losses, the lower government borrowing programme for the first half of 2018-19 and the indication of an extended pause by the Monetary Policy Committee (MPC).

While the MPC has lowered the inflation forecast for the first half of 2018-19 , as well as the second half , there is a low likelihood of a change in the stance of monetary policy over the next few months, until clarity emerges on the impact of the minimum support prices (MSPs), monsoon dynamics and fiscal risks on the inflation trajectory.

Looking ahead, the actual appetite for FPIs remains to be seen, considering the development of the global markets and the likely hardening in interest rates globally over the course of 2018. As of now, it appears the volatility in bond yields seen in Q4 FY2018 is showing no signs of dissipating in Q1 FY2019.

The writer is Senior Vice-President and Group Head, Financial Sector Ratings, ICRA.

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