Context: The Reserve Bank of India (RBI) has relaxed norms for foreign portfolio investors (FPIs) investing in corporate debt securities through the general route.
Relevance of the Topic: Prelims: Key facts related to FPI norms.
Major Highlights:
- Foreign Portfolio Investors (FPIs) in corporate debt securities will no longer be required to adhere to the short-term investment and concentration limits. The decision, effective immediately, aims to provide greater ease of investment for FPIs.
Earlier Regulations
- Short-term investment limit: FPIs were restricted from investing more than 30% of their total investment in corporate debt securities with residual maturity up to one year.
- Concentration limit: For long-term FPIs, investment in a single corporate issuer could not exceed 15% of their corporate bond portfolio. For other FPIs, this limit was 10%.
Now both these limits have been withdrawn. FPIs can now invest more freely in corporate debt securities, without being constrained by maturity or issuer concentration limits. This relaxation comes in the backdrop of the financial markets facing volatility due to geopolitical tensions and tariff wars.
Corporate Debt Securities:
Financial instruments issued by companies to raise funds from investors. In return the companies offer the investors regular interest payments and the return of principal at maturity. E.g., Corporate bonds, debentures, Non-Convertible debentures, Commercial Papers etc.
Significance of the Reforms:
- Liberalise India’s debt market: It is a major step toward liberalising India's debt market.
- Retention of foreign capital: It gives more options to FPIs to park the proceeds from their sale in the equity markets in corporate debt securities at attractive interest rates without having to immediately repatriate the proceeds.
- Diversification of Investor base: Attracts a wider range of global institutional investors, reducing dependence on domestic funding sources.
- Improve Market liquidity: Eased investment norms are likely to increase demand for corporate debt instruments, thereby improving market liquidity, reducing cost of capital for firms, and promoting financial deepening.
Challenges
Despite these changes, foreign investors might still hesitate to invest more due to two key reasons:
1. Narrowing US-India 10-Year Yield Spread:
- The 10-year yield spread is the difference between the interest rates (yields) on Indian government bonds and US government bonds.
- A higher spread means Indian bonds offer better returns compared to US bonds, which attracts foreign investors.
- Currently, this spread has narrowed to around 200 basis points (2%), meaning the extra return from Indian bonds is less attractive. This reduces the incentive for FPIs to take the additional risk of investing in India.
2. External Risk Factors:
- External Risk Factors like geopolitical tensions, US Federal Reserve interest rate changes etc. These risks can make investors risk-averse, leading them to prefer safer assets in developed countries.
While the reforms create better long-term conditions for corporate bond market growth, meaningful FPI inflows may only materialise when yields are attractive.