The RBI will allow foreign investors to buy an additional $18.2 billion in government bonds in stages over the next few years, as part of measures introduced on Tuesday to open up domestic markets.
The long-anticipated change involves increasing the government debt limit for foreign investors to up to 5 per cent of the current outstanding amount of bonds.
The increase, to be carried out in stages until March 2018, will translate into 1.2 trillion rupees ($18.19 billion) in potential investment.
The Reserve Bank of India (RBI ) said foreign investors would also be allowed to buy into debt issued by the country's states for the first time, although only up to 2 per cent of outstanding debt, or totalling 500 billion rupees by March 2018.
The actions highlight the growing confidence India can withstand a likely increase in US interest rates later this year, which is expected to lead to selling by foreign investors in most emerging markets.
"These moves should boost inflows," said Leong Lin Jing, an investment manager at Aberdeen Asset Management in Singapore in emailed comments.
"They also signal the RBI's rising confidence in the resilience of India's capital markets. India, particularly versus other EMs (emerging markets), has seen stable capital flows supported by FDI (foreign direct investment) and bond buying."
The RBI announced the market measures as part of a policy review in which it cut its key repo interest rate by a bigger-than-expected 50 basis points.
The benchmark 10-year bond yield dropped as much as 17 basis points to 7.56 per cent, its lowest since mid-July, 2013 after the decision.
Among other measures, the RBI said it would allow Indian companies to issue rupee-denominated bonds with minimum maturity of five years.
The RBI also said it would lower limits on how much government debt banks are mandated to hold in stages, in a move expected to help increase the amount that can be used for loans.
In currency markets, the RBI said it would allow flexibility in managing currency risk for investors in over-the-counter markets in order to make hedging easier.
It also introduced exchange-traded currency futures and options for euro, sterling, and Japanese yen trades against the US dollar.
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