More leg-room for foreign investors in gilts market

MONETARY POLICY MID-TERM REVIEW 2006-07/ DEBT MARKET

The Reserve Bank of India has increased the limit on foreign institutional investor (FII) investments in government securities to $3.2 billion in two stages from the present $2 billion, in a move aimed to deepen the country's debt markets.

"It is proposed to permit FII to invest in securities issued by the Centre and states by an incremental amount of 5 per cent of total net issuance in previous financial year. This would be over and above the current stipulation of investment up to $2 billion. Accordingly, the existing limit of $2 billion will be enhanced in phases to $2.6 billion by December 31, 2006 and, further, $3.2 billion by March 31, 2007," the RBI said.

Though the current investments by FIIs in government securities at $188.53 million, way below the existing ceiling of $2 billion, there are apprehensions whether the move would have the desired impact on the debt markets.

"India is gradually increasing FII participation in debt market. At present, there are stable economic conditions, better reserves and strong market sentiments, with which this decision has been taken and we expect FII participation to go up as these conditions prevail," Jayesh Mehta, head - debt market, DSP Merrill Lynch, said.

He also said the decision might not have immediate implications on the bond market. "There has been few issues where the government has some apprehensions. It is testing waters before coming out with concrete decisions," he said.

Sunil Mehta, country head and CEO of AIG, said: "The proposal to allow short-selling of gilts up to a five-day period and the increase in FII limits for the debt markets will deepen the market. However, more concrete steps could have been taken for much required debt market reforms."

Banks' investments in government securities at Rs 46,914 crore during the current financial year up to October 13, 2006 was higher than that of Rs 3,400 crore in the corresponding period of the previous year.

Adjusted for banks' repo/reverse repo with the RBI under the Liquidity Adjustment Facility (LAF), their investment in Statutory Liquidity Ratio (SLR) securities increased by Rs 30,806 crore during 2006-07 so far as against an increase of Rs 33,578 crore a year ago.

Banks' net investment in government securities as a proportion to their aggregate deposits has been decelerating to accommodate the demand for non-food advances. There has also been substantial support from non-bank entities for the market borrowing programme of central and state governments.