New FPI route will appeal to long-term debt investors, says experts

Investments will be over and above existing limits set for govt, corporate bonds

The proposed new route for foreign portfolio investor (FPI) debt investments will be appeal to long-term investors and give regulatory authorities a better handle on flows, said experts.

The voluntary retention route (VRR) proposed by the Reserve Bank of India (RBI) on Friday does away with regulatory restrictions, that are otherwise applicable, provided FPIs commit to lock-in two-thirds of their investment for a minimum three years. 

Investments under the new route will be over and above the existing FPI limits set for government and corporate bonds. 

Market participants said the VRR route’s biggest draw is the regulatory leeway it provides. 

In April, the RBI said an FPI cannot invest more than a fifth of their corpus in papers belonging to a single corporate group. Also, a paper issued by a single corporate cannot have more than 50 per cent of investment from a single FPI group. 

“This new route will attract investments from long-term investors, as it removes key regulatory restrictions,” says Rajesh Gandhi, a partner at Deloitte Haskins & Sells. “Part of the reason existing limits are not fully utilised is the new restrictions introduced by the RBI.” 

The RBI, in a discussion paper on VRR, said that investment under this route will “broadly be free of the macro-prudential and other regulatory prescriptions.” 

The investment limits under this route will be auctioned with the key allocation criteria being the “retention period”. The RBI has set minimum retention period at three years and FPIs will have to bid over and above this.

.

For instance, if an FPI committing to invest $1 billion for five years will be given preference over another investor committing to invest $2 billion for four years. About 67 per cent of the so-called committed portfolio size (CPS) will have to remain invested at all the time (on end-of-day basis). 
 

Experts said the VRR route would be ideal for sovereign wealth funds, pension funds and central banks, who are typically long-term investors. Ajay Manglunia, executive vice-president, Edelweiss Finance, said that these investors account for a substantial pie of overall FPI investors and the new rules will help promote a long-term investment culture.

However, some believe that the RBI could allow more flexibility. 

“Two-thirds of your investment have to remain deployed all the time. FPIs would need flexibility to sell and re-deploy at any time. The intention behind this is that the money shouldn’t leave the country. RBI can propose a framework to ensure that the money remains in India at the same time investors are forced not to remain invested all the time,” says Bhavin Shah, partner, PwC India. 

Industry observers said that the new rules would be a boost for the private non-convertible debenture (NCD) market as FPIs will get to invest in any paper of their choice without much restriction on how much exposure they can take. 

The new framework is being introduced at a time when domestic markets are seeing record FPI outflows from the debt market. So far this year, FPIs have pulled out more than $7 billion from the debt market. In comparison, FPIs had invested $23 billion into the domestic debt market last fiscal. The FPI outflows coupled with surging crude oil prices and weakening rupee are putting a strain on India’s trade balance. 

Experts said the new route will give the RBI a better handle flows in future. 

"The RBI can have clarity over FPI flows and plan accordingly. The debt investment in India is largely hot money flow, and investors take long position on rupee when it is stable, and then short it when dollar shows signs of strengthening. This needed to be checked," said Jayesh Mehta, head of treasury at Bank of America Merrill Lynch. 

The total investment limit available for FPIs in debt is Rs 6.5 trillion, of which corporate bond investment limit is Rs 2.9 trillion and the rest is for government securities and state development loans. The existing limits are underutilised, experts said, adding that even the new VRR route will only take off in a big way once the rate and currency environment turns more stable.