The yield on the 10-year government bond moved down 10 basis points after the RBI’s policy review on Tuesday.
The cutting of key policy rate by a steep 50 basis points has no doubt cheered the bond markets. The RBI putting up a framework to increase foreign portfolio investor (FPI) limits in debt securities will also have a positive impact in the long-term.
Currently, foreign investors can invest up to $30 billion in government securities. The limits have been fully utilised. According to the RBI, the limits will now be denominated in rupees, so they do not vary with changes in exchange rates.
The limits for FPI investment will be increased in phases to 5 per cent of the outstanding stock by March 2018. According to the quarterly public debt management report put out by the Finance Ministry for January-March 2015, FPIs constitute about 3.6 per cent of the outstanding government securities.
According to the RBI, in aggregate terms, this is expected to open up room for additional investment of ₹1,20,000 crore for government bonds by March 2018 over and above the existing limit of ₹1,53,500 crore.
For this fiscal year, the limits will increase in two tranches — October 2015 and January 2016 — each entailing an increase of ₹13,000 crore in government bonds and ₹3,500 crore in State Development Loans.
While this will open more opportunities for foreign investors, there have been concerns on whether it will make our bond markets more susceptible to outflows. In a recent interaction with BusinessLine , Amandeep Chopra, Head-Fixed Income, UTI MF, said that linking FPI limits to outstanding government bonds, will cap FPI exposure to a certain percentage of total outstanding so that their outflows do not distort the markets.
According to Suyash Choudhary, Head – Fixed Income at IDFC AMC, the RBI very clearly has a mandate for progressive capital account convertibility, with the pace of such progression tied to the underlying improvements in our macro-economic parameters. “Thus as our funding risks continue to close, inflation differential versus the rest of the world converges further, and fixed income markets continue to deepen, we can move towards much greater FPI participation without fear of undue volatility as a result”.
In other emerging markets, foreign investors have a larger holding in sovereign debt. According to a report published by AsianBondsOnline, foreign holdings in the Indonesian bond market is a whopping 38 per cent as of March 2015, while that in Malaysia is 31 per cent. These countries remain more vulnerable to an exodus of funds from their bond markets.