The Reserve Bank of India (RBI), India's central bank, has banned on Indian banks buying new issues of infrastructure bonds. The prohibition clearly handicaps Prime Minister Narendra Modi's chances of attracting investments needed for infrastructure projects.
Elected in May, Modi aims to promote infrastructure investment and construction of affordable housing with a value of $2 trillion by 2022.
The government in mid-July encouraged banks to issue bonds to fund infrastructure
by exempting these bonds from reserve requirements, in order to enable them to extend cheaper loans to the infrastructure sector. However weeks later the RBI has issued guidelines that barred banks from buying bonds issued by other banks in order to avoid circular trading, whereby lenders agree to buy each other's bonds
According to analysts, this will hamper secondary market liquidity and prevent the creation of a deeper market
as banks are traditionally the biggest buyers of debt. Indeed it's likely that other investors will not buy the bonds either due to the liquidity trap. Premium prices will also be demanded if there is no liquidity.Since the guidelines were given, ICICI Bank Ltd
, Kotak Mahindra Bank Ltd and Andhra Bank Ltd managed to raise just 49 billion rupees ($811 million) in infrastructure bonds. None could exercise their greenshoe options, or the extra amount that issuers sell if they see strong demand.According to sources, industry players demand that the RBI ease the restrictions. RBI could simply limit what percentage of a bank's net capital could be invested in infrastructure bonds. Or it could allow banks to buy and trade bonds for a certain number of days in order to make a market and ensure liquidity.