Sebi's new bond buy rule likely to dampen FII demand for debt

MUMBAI: Foreign institutional investors could shy away from short-term debt instruments after Sebi said FIIs have to buy new investment limits to reinvest fund in debt once they have sold or redeemed existing holdings.

The move will support the government's agenda of attracting long-term foreign capital, said market experts.

Earlier, the limit remained unchanged if an FII reinvested the proceeds in a new debt instrument within five days of sale or maturity of a bond.

"FII entities had previously been actively buying and selling at the short-end of the curve (less than one year) to limit withholding and capital gains taxes. The latest change will reduce potential hot money flows towards the short-end and may lead to distortion in this part of the curve," said an HSBC report.

Experts said the move may lower premium pricing, but will increase premium earnings for the regulator as FIIs will now have to pay premium on buying new limits every time they need to reinvest their funds.

"The new circular could bring about better pricing of limits, since it will increase the supply, freeing up the limits. The current premium of 1-1.5% is too expensive for any FII," said Ajay Manglunia, head - fixed income, Edelwiess Financial Services.

In December, Sebi garnered Rs 500 crore from premium that FIIs paid to buy bond investment limits.

The new guideline will be effective from January 2, 2014, for FIIs who have already bought limits. For new investors, who buy limits from auctions in the coming months, limits will lapse after the sale of investment.

Debt analysts said the move is also likely to free up debt investment that had been the monopoly of a few large FIIs, who bought the limits long back at a much lower premium, than what is charged today due to rising demand for Indian debt.