The Securities and Exchange Board of India on Thursday announced a $500 million cap on foreign institutional investors' investments in corporate bonds.

This limit is over and above the $1.75 billion overall ceiling on FII investments in the Indian debt market. Thus, foreign funds can invest up to $2.25 billion {approximately Rs 9,900 crore (Rs 99 billion)} in Indian debt, including government securities, treasury bills and corporate debt.

Corporate bond prices slumped and yields increased by 20-30 basis points after the Sebi announcement. Secondary market trading volumes dipped to about Rs 100 crore (Rs 1 billion) on Thursday as against Rs 120 crore (Rs 1.2 billion) on Wednesday.

The yield on the benchmark 5.85 per cent HDFC 2009 paper increased from Wednesday's close of 6.75 per cent to 7.00 per cent on Thursday.

The spread between the yields of corporate bonds and government bonds of corresponding maturity widened on Thursday from 20 basis points to 40-50 basis points.

According to bond dealers, domestic investors were seen dumping debt paper they had bought aggressively in the last two days, expecting to sell it further to FIIs.

But Thursday's Sebi clarification closes that opportunity and, therefore, investors were forced to sell at any price. Foreign banks and mutual funds were said to have lapped up debt paper earlier.

Rajiv Anand, head of debt investments at Standard Chartered Mutual Fund, said, "The immediate impact of the news was there was a vicious selloff in order to reduce positions." He pointed out that any outstanding positions over the current cap would now be taken on the books of Indian brokers.