RBI eases FPI investment ceiling in Corporate Debt Securities. Let’s learn more!

Key Points of Interest:

Foreign Portfolio Investors (FPIs) in corporate debt securities will now be exempt from the short-term investment and concentration limits. The decision, effective right away, seeks to offer enhanced investment convenience for FPIs.

Previous Regulations

Short-term investment cap: FPIs were limited to investing no more than 30% of their total assets in corporate debt securities that have a remaining maturity of up to one year.

Concentration limit: Long-term FPIs cannot invest more than 15% of their corporate bond portfolio in a single corporate issuer. For different FPIs, this cap was 10%.

Currently, both of these restrictions have been lifted. FPIs can now invest more freely in corporate debt instruments, without being restricted by maturity or issuer concentration limits. This easing occurs against the backdrop of financial markets experiencing instability due to geopolitical conflicts and trade wars.

Corporate Debt Instruments:

Securities released by firms to gather capital from investors. In exchange, the companies provide investors with consistent interest payments and the repayment of principal upon maturity. For instance, corporate debt securities, debentures, non-convertible debentures, commercial papers, etc.

Importance of the Reforms:

Liberalizing India’s debt market: This is a significant move towards opening up India's debt market.

Retention of foreign capital: It provides FPIs with additional opportunities to invest the returns from their sales in corporate debt securities within the equity markets at appealing interest rates without the need for immediate repatriation of the funds.

Broadening the Investor base: Captures a broader spectrum of international institutional investors, decreasing reliance on local funding sources.

Enhance market liquidity: Relaxed investment regulations are expected to boost demand for corporate debt securities, subsequently enhancing market liquidity, lowering capital costs for companies, and fostering financial deepening.

Obstacles

Even with these alterations, international investors may still be reluctant to increase their investments for two main reasons:

The 10-year yield spread refers to the disparity between the interest rates (yields) of Indian government bonds and those of US government bonds.

A larger spread indicates that Indian bonds provide superior returns compared to US bonds, drawing in foreign investors.

At present, this spread has tightened to approximately 200 basis points (2%), indicating that the additional yield from Indian bonds is now less appealing. This diminishes the motivation for FPIs to assume the extra risk of investing in India.

External Risk Factors such as geopolitical conflicts, changes in US Federal Reserve interest rates, etc. These risks may cause investors to become risk-averse, prompting them to choose safer assets in developed nations.

Although the reforms improve long-term prospects for the growth of the corporate bond market, significant FPI inflows might only occur when yields are appealing.