STRIPS Capped, Hopes Clipped: Insurers Urge RBI to Think Long-Term

India's insurance giants are sounding alarm that the Reserve Bank of India's (RBI) recent limit on state government debt STRIPS (Separate Trading of Registered Interest and Principal of Securities) by the central bank can significantly lower demand from the sector. This can slow down the central bank's efforts to deepen the state bond market.

 

Key Highlights:

 

RBI's New STRIPS Rule: RBI allowed stripping of state government bonds some time ago—only those with residual maturity of up to 14 years. This is a very restrictive constraint because nearly half of all state debt is in longer maturity bonds.

 

Insurers Prefer Longer Maturities: Life insurers, the largest purchasers of STRIPS, prefer bonds with 20 years or more to match their long-term obligations to policyholders. The 14-year cutoff is a major restriction for them.

 

Demand at Risk: Rahul Bhuskute, the CIO at Bharti AXA Life Insurance, expects that the RBI will eventually be compelled to relax this regulation, perhaps allowing STRIPS on bonds with maturities of 30 years and above to meet the market's requirements.

 

Market Impact: Over 50% of the ₹1.1 trillion value of state bond issuance during the April–June quarter alone was in maturities exceeding 14 years. With another ₹8 trillion arriving in similar maturities in the subsequent three quarters, the cap might leave out a major chunk of the market from STRIPS eligibility.

 

Insurer Views: Sachin Bajaj, Axis Max Life Insurance, stated that insurance corporations have liabilities that extend for more than 40 years and therefore long-dated STRIPS are a necessity. Insurers also employ STRIPS in order to match asset-liability cash flows more effectively and minimize reinvestment risk.

Yield Premium: State bond STRIPS are receiving a 30–40 basis point yield premium over central government STRIPS and thus are very appealing to long-term investors such as pension funds and insurers.

 

Portfolio Management and Liquidity: STRIPS allow insurers to extend portfolios and synchronize cash flows with ultimate payments with precision, a useful function for the firm.

 

Conclusion:

 

While RBI's move to open up STRIPS in state bonds is in the right direction for market development, the 14-year maturity cap is seen as a strong disincentive. Unless the duration cap is eased, insurers warn that the demand for these instruments will be tepid, and RBI's broader market development agenda can be slowed down. 

 

Source: Reuters, Economic Times