India plans to allow banks to buy infrastructure bonds

The Reserve Bank of India is considering allowing banks to buy infrastructure bonds, in a bid to jumpstart a market that has suffered from low trading volumes after launching last year, said a source with knowledge of the central bank’s thinking.

Allowing banks to buy infrastructure bonds would mark a reversal for the central bank, which last year allowed lenders to only issue the debt, while limiting purchases to investors such as pension funds, provident funds, and insurers.

That limitation has backfired, according to bankers, severely crimping trading volumes in the market since lenders are the biggest buyers and traders in debt markets.

Reviving investment in infrastructure is a key priority for Prime Minister Narendra Modi which has been looking to ease regulations and bottlenecks to spur the sluggish economy.

“We are quite flexible on the suggestions of allowing banks to initially develop this market by buying a certain percentage of the (infrastructure) bonds,” said a top policymaker.

However, the policymaker cautioned the RBI could impose limits, including on how much of the debt lenders can purchase, or allowing them to hold the bonds for only a short period of time and then requiring them to sell it to long-term investors.

That could soothe the RBI’s concerns that risks are being excessively concentrated in debt markets, given banks are often the biggest issuers but also the biggest buyers — meaning lenders end up purchasing each other’s bonds.

Infrastructure bonds were launched by the RBI last year in a bid to help the government fulfill its plan to provide affordable housing to all by 2022, a goal that needs about $2 trillion of investment.

Banks issue the debt and use the proceeds to fund infrastructure projects.

“Allowing banks to invest in infrastructure bonds would help improve primary and secondary market liquidity,” said Shashikant Rathi, senior vice-president and head of investments, capital markets and asset liability management at Axis Bank.

Since their launch in August, only around 150 billion Indian rupees ($2.42 billion) of infrastructure bonds have been issued, well below the 500 billion rupees worth of debt that traders had estimated could have been raised within the first year.

Under Governor Raghuram Rajan, the RBI has been keen to develop debt markets to increase investor interest. The central bank successfully launched bond futures last year, after two previous attempts at launching bond futures in 2003 and 2009 failed because of what traders said were poor designs.