Govt restrictions on FII investments in corporate debt a dampener

The 3-year maturity clause likely to impact overseas investments in corporate papers, says Nishith Desai

The new restrictions imposed by the government on foreign institutional investors' (FII) investments in corporate bonds could be a dampener for the development of the domestic bond market. It is also likely to make things tough for Indian companies, who raise capital from foreign investors through short-term loans.

“The introduction of minimum three years residual maturity requirement is a major dampener for FPIs and corporates,” leading corporate law firm Nishith Desai Associates said in a note.

The move is likely to hamper the development of the corporate bond market in India, which already lags behind other regional peers such as China and South Korea.

According to Nishith Desai, the domestic corporate bond market at $242 billion is much smaller than China’s $1.65 trillion, South Korea’s $1 trillion and Japan’s $786 billion.

Earlier this month, the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (Sebi) issued circulars restricting FPI investments in bonds with residual maturity of three years or more.

The move, aimed at attracting stable flows, means that all future investments by FIIs will have to be in corporate papers that are to mature in not less than three years. The move disallows FIIs from investing in short-term instruments like liquid and money market mutual funds.

Currently, India allows FII investments of $51 billion in the corporate debt market. However, less than 70% of the limits have been used by overseas investors. This is contrary to their investments in government debt where the entire $30 billion limit is exhausted. 

Nishith Desai said the new norms “don’t augur well with the intention of the government to encourage debt.” 

The law firm has also spelled out the various difficulties that Indian corporates would face on account of the new restrictions.

“Imposition of three year residual maturity requirement would not only impact shorter term loans, it would also restrict various contractual arrangements like call / put option vis-à-vis the issuing company, part redemptions etc,” it said.

The curbs will prove to be deterrent in having prepayment clauses in loans arrangements with overseas investors.