MUMBAI, August 11: The Reserve Bank of India has allowed foreign institutional investors (FIIs) to book forward cover for their investments in debt instruments. This step is likely to weaken the rupee and push forward rates to more realistic levels.

The Reserve Bank has said in a press release that it has permitted banks to provide forward cover to FIIs for debt instruments. "The extent of the cover will be limited to the current market value of the investments in debt instruments translated in dollar terms. The tenor of the cover shall not exceed the remaining period to maturity of the debt instruments in which the FII has invested," the RBI statement said.

Analysts said this step is in line with the recommendations of capital account convertibility committee headed by former RBI deputy governor SS Tarapore. "It is a very good development and will go a long way in deepening the forex markets," Tarapore said. He added that the apex bank had done the right thing by allowing forward cover only for debt instruments. "Debt instruments reflect the true interest rates while stocks do not," Tarapore said.

Forex dealers said the development was likely to create the much needed demand for dollars. "Forward rates are likely to rise from such low levels of 3.7 per cent (six-monthly annualised). It should be allowed to rule at more realistic levels and this can be done if there is lesser receiving pressure," a dealer with a foreign bank said.

Bankers said that the step will create more players in the forex market. "The market has to deepened. The rupee has been appreciating and a lack of players has seen dollar supplies outstripping demand. The inching up of forward rates will see the rupee weaken", a senior central banker said.

Moreover, with this step players expect the three-year and five-year forward cover market to take off finally. "So far there have been quotes only and not many deals have been struck. Now one can look forward to a forward curve upto five years," a dealer with a leading private sector bank said.

FIIs have termed the step a major one, which could open the flood gates of foreign debt funds flow into the country. Foreign funds have hitherto been fighting shy of investing in Indian debt despite several encouraging factors and measures announced.

"Probably, this is one of the single most important measure announced to invite foreign debt funds," said Nilesh Shah, fund manager, Templeton Global Bond Managers.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.