The cap on government bond holdings by foreign institutional investors (FIIs) might be increased in the first half of the next financial year because of the government’s higher gross market borrowings and expected rate increases by the US Federal Reserve.
As banks are sitting on excess statutory liquidity ratio (SLR), the Reserve Bank of India (RBI) is in the process of reducing SLR on a systematic basis, owing to which these entities might not have much appetite for bonds.
“There is a general expectation that next financial year, there will be some increase in the FII limit in government bonds. People are expecting it might happen either in the Budget or at the beginning of the new financial year, at RBI’s April monetary policy. There is an expectation of a fresh $5-billion limit enhancement, but such expectations have been there for a while,” said Jayesh Mehta, managing director and country treasurer at Bank of America-Merrill Lynch.
The FII limit of $30 billion in government bonds is nearly full. As such, the interest has been shifting to corporate bonds, where the limits are still some distance away. RBI has barred FIIs from investing in short-term debt to encourage long-term flows and reduce dependence on hot money. It hasn’t allowed fresh foreign investment in government bonds since raising the ceiling to $30 billion in 2013.
The Street expects the government’s gross market borrowings for FY16 at about Rs 6 lakh-crore, compared with Rs 5.92 lakh-crore for this financial year.
“Ideally, they should have a predictable programme for managing these limits on an ongoing basis. I think they will definitely enhance the limit by at least $5 billion, if not more, during the course of the year. The demand is definitely there,” said Ananth Narayan, regional head (financial markets), South Asia, Standard Chartered Bank.
The US Federal Reserve is expected to raise interest rates this year and when that happens, India might see FII outflows, owing to which limits in government securities might be enhanced earlier. So far this financial year, net FII flows in debt stand at $25.1 billion.
In its monetary policy review earlier this month, RBI had decided to enable reinvestment of coupons in government securities when existing limits were fully utilised. This was aimed at incentivising long-term investors. “We would not like to be seen as against foreign investors and given we want to expand limits on a regular basis, given the interest in India today, if we just expand the foreign portfolio investors limit in government securities by some, let us say $5-10 billion, that will be taken up in couple of weeks and we will still get people wanting us to open more,” RBI Governor Raghuram Rajan had said after the monetary policy review.