It is necessary to ensure that this 'support' does not turn into a 'burden' going ahead
Every time there is a currency crisis, various ideas are suggested to tide over the same. The idea mooted this time is to get in big dollar flows through special bonds. This way we get in long-term funds that are locked for a predetermined period of time at a fixed cost. The questions that arise are: Do the conditions warrant such an attempt? What should be the quantity that can be raised and for what period? What should be the offer rate? What kind of concessions have to be given? Are there any underlying risks for such a scheme? The idea of getting in sovereign debt funds to invest is a novel idea which is being explored today but getting in investors, especially NRIs, to put their money in bonds is not new. We had two experiments that were fairly successful in the past that can be replicated today. The first was called Resurgent India Bonds that were raised in 1998 for five years at a dollar cost of 7.75%. The risk was borne by the State Bank of India (SBI) and there were tax benefits provided in the form of wealth tax, income tax, and a total of $4.23 billion was garnered through this scheme. The interest rate paid was higher than LIBOR by 225 bps. A similar scheme was launched in 2000 called India Millennium Bonds (IMD), which got in around $5 billion. The rate offered was 8.5% which was 175 bps above LIBOR for the same terms as the RIBs, with the difference being that the forex risk was shared between SBI and the government. Commissions too were paid to attract such deposits. The economic conditions during these time periods were similar. In 1998, at the time of RIBs, we had $24.8 billion of foreign currency assets which, based on FY98 imports, provided cover for around seven months. In 2000, when IMD was launched, the reserves stood at $32 billion and covered 7.7 months of imports based on FY2000 numbers. Today, with our currency reserves at around $260 billion and imports of $500 billion, the cover is 6.2 months. Clearly, there is a deficiency of dollars which merits such a consideration. How should the bond be priced for five years? LIBOR is at around 0.70% and pricing it at, say, 225 bps higher would mean 3%, which is not adequate given that US 10-year gilts provide a yield of 2.2%. More importantly, FCNR deposits of five-year tenure by Indian banks offer 4.2% and hence, to attract funds, the rate has to be above this mark. Besides, if one keeps aside the nationalist spirit, we would be competing with other emerging markets. Therefore, the rate has to be necessarily higher than 4.2% to attract investors. Further, with the expectations of higher interest rates in the western world, the benchmark rates would increase, which has to be factored in. The forex risk would be high and it has to be borne by the government—a cumulative depreciation of even 2% on an annual basis will push up the principal repayment amount by 10%. What should be the targeted amount? On the last two occasions the amount raised was around 15-20% of the existing foreign currency assets. The same today would be hard to collect and service as it would amount to around $40-65 billion. At the same time, the amount has to be significant to make a difference as a similar number of $5 billion will not make much difference. But a high number will add to our external debt, which is rising prodigiously. Therefore, an amount of around $20 billion looks more reasonable. What are the downsides? The first is that if the rates are very attractive, then NRIs could move out from FCNR deposits, which will lead to just a substitution and we may not really be better off at the end of the day. Second, any debt raised is analogous to ECBs being borrowed and adds to our external debt. We need to be sure what these dollars are going to be used for. If they are to be used only to strengthen reserves and improve sentiment, then the implicit cost is much higher. If they were to be used for productive purposes, then it may just be the same to increase ECB limits and get the private sector to get the dollars. Third, getting in such a sum at a point of time would also mean issues of monetisation as RBI will have to sterilise these flows at a time when inflation is a still a concern. If, however, the government stacks up these dollars, then this issue will be eschewed but finally would have to be released to balance the external account. Fourth, the exchange risk, which was taken on by SBI/government earlier, has to be hedged as the quantity we are dealing with will be much higher. Last, any amount raised would mean repayment on due date and hence will add to the pressure in the terminal year. To answer all the questions posed in the beginning. First, we certainly do need to shore up our foreign currency assets so that we are able to tackle the CAD which is losing support from FIIs. As QE will end some time for certain, capital flows are required to provide support. The present import cover is not too comfortable. Second, we should borrow around $20 billion for a long term of at least five years. A call/put option can be considered however. Third, the rate has to be higher than the FCNR rate given that LIBOR benchmarking will not be attractive. A thought, however, is to have a flexi rate linked to a benchmark, which could be challenging today. Fourth, tax concessions may have to be retained similar to what was offered earlier. The downsides remain and the government or any bank which takes on this onus should hedge effectively to cover the exchange risk. Careful structuring of the product would be necessary to ensure that this ‘support’ does not turn into a ‘burden’ going ahead.
Every time there is a currency crisis, various ideas are suggested to tide over the same. The idea mooted this time is to get in big dollar flows through special bonds. This way we get in long-term funds that are locked for a predetermined period of time at a fixed cost. The questions that arise are: Do the conditions warrant such an attempt? What should be the quantity that can be raised and for what period? What should be the offer rate? What kind of concessions have to be given? Are there any underlying risks for such a scheme? The idea of getting in sovereign debt funds to invest is a novel idea which is being explored today but getting in investors, especially NRIs, to put their money in bonds is not new. We had two experiments that were fairly successful in the past that can be replicated today. The first was called Resurgent India Bonds that were raised in 1998 for five years at a dollar cost of 7.75%. The risk was borne by the State Bank of India (SBI) and there were tax benefits provided in the form of wealth tax, income tax, and a total of $4.23 billion was garnered through this scheme. The interest rate paid was higher than LIBOR by 225 bps. A similar scheme was launched in 2000 called India Millennium Bonds (IMD), which got in around $5 billion. The rate offered was 8.5% which was 175 bps above LIBOR for the same terms as the RIBs, with the difference being that the forex risk was shared between SBI and the government. Commissions too were paid to attract such deposits. The economic conditions during these time periods were similar. In 1998, at the time of RIBs, we had $24.8 billion of foreign currency assets which, based on FY98 imports, provided cover for around seven months. In 2000, when IMD was launched, the reserves stood at $32 billion and covered 7.7 months of imports based on FY2000 numbers. Today, with our currency reserves at around $260 billion and imports of $500 billion, the cover is 6.2 months. Clearly, there is a deficiency of dollars which merits such a consideration. How should the bond be priced for five years? LIBOR is at around 0.70% and pricing it at, say, 225 bps higher would mean 3%, which is not adequate given that US 10-year gilts provide a yield of 2.2%. More importantly, FCNR deposits of five-year tenure by Indian banks offer 4.2% and hence, to attract funds, the rate has to be above this mark. Besides, if one keeps aside the nationalist spirit, we would be competing with other emerging markets. Therefore, the rate has to be necessarily higher than 4.2% to attract investors. Further, with the expectations of higher interest rates in the western world, the benchmark rates would increase, which has to be factored in. The forex risk would be high and it has to be borne by the government—a cumulative depreciation of even 2% on an annual basis will push up the principal repayment amount by 10%. What should be the targeted amount? On the last two occasions the amount raised was around 15-20% of the existing foreign currency assets. The same today would be hard to collect and service as it would amount to around $40-65 billion. At the same time, the amount has to be significant to make a difference as a similar number of $5 billion will not make much difference. But a high number will add to our external debt, which is rising prodigiously. Therefore, an amount of around $20 billion looks more reasonable. What are the downsides? The first is that if the rates are very attractive, then NRIs could move out from FCNR deposits, which will lead to just a substitution and we may not really be better off at the end of the day. Second, any debt raised is analogous to ECBs being borrowed and adds to our external debt. We need to be sure what these dollars are going to be used for. If they are to be used only to strengthen reserves and improve sentiment, then the implicit cost is much higher. If they were to be used for productive purposes, then it may just be the same to increase ECB limits and get the private sector to get the dollars. Third, getting in such a sum at a point of time would also mean issues of monetisation as RBI will have to sterilise these flows at a time when inflation is a still a concern. If, however, the government stacks up these dollars, then this issue will be eschewed but finally would have to be released to balance the external account. Fourth, the exchange risk, which was taken on by SBI/government earlier, has to be hedged as the quantity we are dealing with will be much higher. Last, any amount raised would mean repayment on due date and hence will add to the pressure in the terminal year. To answer all the questions posed in the beginning. First, we certainly do need to shore up our foreign currency assets so that we are able to tackle the CAD which is losing support from FIIs. As QE will end some time for certain, capital flows are required to provide support. The present import cover is not too comfortable. Second, we should borrow around $20 billion for a long term of at least five years. A call/put option can be considered however. Third, the rate has to be higher than the FCNR rate given that LIBOR benchmarking will not be attractive. A thought, however, is to have a flexi rate linked to a benchmark, which could be challenging today. Fourth, tax concessions may have to be retained similar to what was offered earlier. The downsides remain and the government or any bank which takes on this onus should hedge effectively to cover the exchange risk. Careful structuring of the product would be necessary to ensure that this ‘support’ does not turn into a ‘burden’ going ahead.
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