Higher Foreign Investment Limit In Corporate Bonds May Benefit PSUs Most
A customer counts Indian rupee banknotes at a store. (Photographer: Dhiraj Singh/Bloomberg)

Higher Foreign Investment Limit In Corporate Bonds May Benefit PSUs Most

The government’s decision to increase the limit for foreign portfolio investment in corporate bonds may benefit public sector companies and AAA-rated firms, as overseas investors continue to play it safe in the Indian credit markets.

The immediate impact of the announcement, however, would be limited as existing limits are yet to be fully utilised.

As part of the Union Budget presentation on Saturday, Finance Minister Nirmala Sitharaman said that the limit on foreign investment in corporate bonds would be increased to 15 percent of the outstanding amount compared to 9 percent earlier. The increased limit for corporate bonds came alongside a move to fully open up certain specific government securities to foreign investors.

No Immediate Impact

The existing limit of 9 percent of outstanding bonds translated into Rs 3.17 lakh crore worth of investments. About 58 percent of this limit has been utilised, shows data from the National Securities Depository Ltd.

To be sure, its not just corporate bond limits that have been under-utilised. Even government bond limits, set at 6 percent of the outstanding stock, remain available.

According to data from the Institute of International Finance, foreign investors have a $115 billion emerging markets portfolio, of which Indian bonds account for only 5 percent. Roughly half of the amount allocated has been invested in corporate bonds.

Investors haven’t used up existing limits because India has experienced a few shocks and uncertainties in the last few years. Growth has slowed and since 2016 quite a few events hit the economy from demonetisation, GST implementation to stress in parts of the shadow banking system, and an uncertain outlook in sectors such as telecom.
Sergi Lanau, Deputy Chief Economist, Institute of International Finance

Who Could Benefit?

Still, should foreign investment in Indian corporate debt pick-up, who would be the likely beneficiaries?

Data from Bloomberg shows that the ten largest FPI investors in India have shown a preference for bonds issued by PSUs due to the comfort of sovereign backing, followed by a select set of financial firms, infrastructure and energy companies.

These ten FPI have a combined India corporate bond portfolio of over Rs 82,800 crore, the data shows. Popular investments include government-owned firms like Power Finance Corporation Ltd., REC Ltd.. Indian Oil Corporation Ltd. and even Food Corporation of India. Among private issuers, FPIs have leaned towards paper from banks like HDFC Bank Ltd. and ICICI Bank Ltd. , along with telecom firms like Reliance Jio Infocomm Ltd. and Bharati Airtel Ltd.

FPI decision making on Indian corporate debt is still largely driven by a macro view of the country and currency risk, said Jayesh Mehta, India country treasurer for Bank of America. “Around 75 to 80 percent of foreign investors look at the stability of the currency when they are deploying funds globally, rather than the bond value,” Mehta said. Beyond that, FPIs will look for high-yielding bonds and they prefer government securities over AAA-rated firms.

Ajay Manglunia, head of institutional fixed income at JM Financial, added that NBFC bonds were seen as attractive till two years ago but foreign investors have now turned cautious as well.

Whether they are banks, wealth funds or pension funds, FPIs are more comfortable with the bonds issued by PSUs as they score higher on the liquidity side. They are looking more at safety, liquidity and credit risk rather than just yields.
Ajay Manglunia, Head of Institutional Fixed income, JM Financial

This could change if newer issuers come to the market.

Rajesh Pawar, director at quantitative finance and research firm I-Peritus Solutions and Services Pvt. Ltd., said that FPIs are actively seeking investment options but new issuers, such as manufacturers, capital goods players and services companies, need to increase their borrowings from the domestic corporate bond market.

“The majority of issuers in the last year have been PSUs, non-banks and power companies and they have used bonds to replace bank term loans. Companies need to go beyond raising bonds just for working capital or general corporate purposes,” he said. Even bonds issued by state-run entities need to adopt new and innovative structures to attract more FPI funding, Pawar said, citing the example of the Masala Bond issued by the Kerala Infrastructure Investment Fund Board last year.

The Two Different Routes

Another reason behind the under-utilisation of limits for corporate bonds is that the Reserve Bank of India has offered investors another option.

In 2018, the RBI introduced a ‘voluntary retention route’, under which foreign investors were allowed easier operational terms of investment provided they committed to staying invested for three years. In the first two tranches of the VRR scheme, FPIs purchased Rs 54,300 crore in debt. Nearly 93 percent of the amount invested went towards corporate bonds.

Prior to the budget announcement, the RBI raised the limit for debt investments by FPIs via the “voluntary retention route” to Rs 1.5 lakh crore from Rs 75,000 crore.

“Prior to April 2018, there was a large supply of funding from FPIs in corporate bonds as foreign investors were using their group FPI entities to infuse capital in local companies, through a mix of debt and equity,” said Alok Mundra, partner - deal advisory at KPMG in India. Thereafter, the RBI issued regulations on security-wise limit, single/group investor-wise limit and concentration limits for FPIs, which made it difficult for foreign investors to use their group FPI entities to fund these transactions, he said.

“Then the RBI opened the VRR scheme in 2019, so a part of the FPI debt flow to corporate bonds has come through this route, which is why there is an under-utilisation of the overall quota,” Mundra said, adding that increasing the FPI limit for corporate bonds on a standalone basis may not help in higher participation in the bond market unless coupled with changing some of existing restrictions.

Manglunia shared that view. The flow of funds will pick-up only when the overall environment improves and when FPIs are more comfortable, he said. “The demand for non-PSU bonds by FPIs will rise when the coupon rates on PSU bonds fall as liquidity improves and interest rates transmit,” he added.

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