The falling rupee is being watched closely with a clarion call being made to lower forex spending, which includes purchase of gold, foreign travel or use of petrol-diesel vehicles. There is also a discussion on the necessity of shoring up our forex reserves through either a bond issuance, or a swap that was done earlier. How serious is the issue today?
The declining rupee is a concern as the fundamentals of our balance of payments show that demand is higher than supply for forex. But is this leading to a crisis? The answer is ‘no’ because with reserves of around $690 billion, there is an import cover of 11 months. Anything above eight months is comfortable, and concerns can arise when it falls below this threshold.
The situation is not akin to 2013 when there was a sharp fall in reserves and the RBI came up with the swap plan. At that time India was part of what was called the ‘fragile five’ countries. In 1998, to deal with sanctions imposed due to Pokhran nuclear explosions, the RIBs (Resurgent India bonds) were issued. In 2000, India Millennium bonds were floated in the wake of an oil crisis. The present situation is not as alarming.
Even so, the government and the RBI must put in place a contingency plan, in case things get out of hand. Customs duty has been hiked to 15 per cent from 6 per cent, to curb gold imports. Curbing imports is a good idea, but takes time to work out as price may often not be a limiting factor. Imposing quotas is an option but that will send a different message to investors on the state of the economy. Besides, any quantitative restriction invariably leads to the emergence of a black market. Therefore, the primary focus has to be on getting in forex; curbing expenditure can only be a secondary option.
Bond design
or raising forex through bonds or deposits, various factors have to be considered while designing the product. The first is the availability of investible funds with an investor class. This applies to both Indian expatriates as well as foreign investors. The latter have been in withdrawal mode in the equity market. FDI repatriations have been increasing — a sign of a perceived lack of opportunities in India or preferences for other markets for surpluses generated. Hence, the main target would have to be expat Indians and NRIs. But does this segment have investable funds?
There are apprehensions over the flow of remittances or NRI deposits from the Gulf countries, due to the Iran war. This is mainly due to the earnings of this section coming down — which, in turn, means that this population cannot really be targeted. So, bonds or deposits will have to be directed at a more affluent segment, which can also include foreign residents looking for better returns.
Typically bonds issued must be for five years. Now, the deposit rate for NRIs is in the region of 4-4.5 per cent. The risk here is that the existing NRI deposits could shift to higher yielding deposits/bonds if terms are substantially better.
Similar tenure deposits in the US (with credit unions) earn around 3.5 per cent, Germany 2.25-2.75 per cent, UK 3.75-4 per cent, UAE 4-4.5 per cent. With inflation rising worldwide due to the oil prices, central banks could start raising interest rates, which has to be factored in when reckoning returns for these bonds/deposits.
The exchange rate risk has to be added to the rate offered on these instruments. Fixing the coupon rate at this juncture is tricky. Corporate bonds in the US give a return of 4.8-5.5 per cent. The US Treasury averaged 4.5 per cent. Therefore, the return has to be upwards of 5 per cent. Add to this the exchange rate risk of 3-4 per cent depreciation, and the cost of such deposits would be in the region of 8-9 per cent, which looks higher compared with domestic resources.
The government could allow for interest being tax-free in the hands of the investor. The advantage here is that we can circumvent the withholding tax issue which has been vexatious for FPIs.
Tax matters
Also a decision has to be taken on early redemption for both sides — through call and put options — as conditions can change any time. If the war ends and things return to normal, the the coupon rate would be too high. Also the instrument has to enable transferability for investors. Therefore, listing on exchanges, domestic and international, can be considered.
Another issue to be borne in mind is whether these would be bearer bonds or involve the identity of the individual investor to be disclosed. Bearer bonds are easier to handle. Insisting on names involve KYC procedures which can be onerous for investors given the re-KYC rule which is used for domestic citizens. Having bearer bonds can, on the other hand run the danger of round tripping and white-washing of funds. In the prevailing context, it is worth weighing the pros and cons.
Once all these considerations are deliberated upon and a decision taken, the product can be kept ready to be rolled out at an opportune time.
The catch here is that if the issuance is to shore up reserves and ensure that a certain level is maintained, the funds cannot be deployed at will, and will have to follow the investment pattern of reserves. If the funds realised are used for lending (in case banks raise these funds), the cost would be much higher and could come in the way of costs and profitability ,as the effective lending rates would rise.
In 2013, the RBI had gone in for the 3.5 per cent swap for three years, where banks could swap for rupees with RBI. The amount mobilised was $34 billion. This time, if we go in for any route to garner forex, the target would have to be at least $50 billion.
The government and RBI can set trigger points for introducing such a scheme. But it makes sense to keep a product ready.
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