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State govt bonds for foreign investors?
Tue, 25 Aug Pre-Open

As per a leading financial daily, the Reserve Bank of India and the Indian government are having preliminary discussions on allowing foreign portfolio investors (FPI) to invest in bonds floated by state governments.

Presently, the exposure to debt securities by overseas investors is capped at US$ 80 billion. Out of this, US$ 30 billion is allowed in gilts or sovereign bonds which are issued by the central government. The balance US$ 50 billion can be invested in corporate bonds. But the state bond market is not open to foreign investors yet.

With the FPI investment in central government bonds already hitting the US$ 30 billion ceiling, will opening up the state bond market be a good idea?

For states, this might emerge as a new source of funding. The better-run states will be able to tap funds at a cheaper rate than the poorly run states. Currently, the borrowing rates for states are not very different despite the differing fiscal conditions. Bringing in FPIs may make the bond market more competitive and efficient.  

The other important question is - Will FPIs be willing to invest in state government bonds?

Typically, FPIs prefer sovereign bonds as compared to state bonds since the former are rated and may seem more secure. Then why would FPIs invest in state bonds? The answer is higher yields. The yields on state bonds are higher by 40 to 50 bps as against the GOI bonds of similar maturities. Also, states would usually not default on interest servicing or repayment as it would then make fund raising very difficult. If the proposal goes through, there would be a new avenue of funds for state governments. But this will call for greater accountability from the states.

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