February 22, 2020
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Well, The Name's Bond

Resurgent India Bonds spell gains for the NRIs and the government, but what of the economy?

Well, The Name's Bond

THREE days after Pokhran II on May 11, Y.V. Reddy, RBI deputy governor, received a call from the finance ministry. The government was expecting the impact of sanctions to be around $2 billion and could this amount be raised from overseas, he was asked. Reddy immediately contacted A.R. Barwe, MD of SBI Capital Markets, M.S. Verma, SBI chairman, and Usha Thorat, RBI general manager. The core team of four assured the finance minister that the amount could be raised provided certain concessions like tax breaks and high interest returns were given. Within two weeks, the Resurgent India Bonds (RIBs) scheme was conceived and ready to be announced in the budget.

Eleven weeks later, at the SBI headquarters in Mumbai, Verma wears the triumphant look of a sprinter at the finishing line. Says he: "We've been able to collect $2.5 billion within 10 days. Barring perhaps Antarctica, we're selling it in every continent. The total mop-up will be about $3-$3.5 billion."

 Indeed, the RIBs have been a roaring success. Here's why:

  • They're offering NRIs in the US a coupon rate of 7.75 per cent per year, 8 per cent in the UK and 6.25 per cent in Germany, two per cent higher than the local applicable rate. Investors would earn about 5.5 per cent from local government bonds in the US, 6 per cent in the UK and 4.75 per cent in Germany. Says Hitesh Gajaria, a chartered accountant in Mumbai: "On an average, the interest rate offered on RIBs is a whopping 200-250 basis points over comparable deposits in the US and at least 150 basis points higher than the best FCNR deposit rates offered by Indian banks."
  • The interest and principal are fully repatriable in dollars, ensuring there's no increased risk associated with the higher returns or linked to the depreciation of the rupee.
  • Foreign banks have found the returns lucrative enough to leverage NRI subscriptions by as high a ratio as 9:1. This dramatically increases investible funds available.
  • Given the high leverage ratio and flexibility to convert dollars to rupees in India in the face of a falling exchange rate, the effective rate of return works out to between 15 and 18 per cent. "Nobody has got a better deal in the history of emerging markets, nor can one hope to find one in a hurry, given the crisis in the rest of Asia," says Manju Juneja, director, Barclays Capital.
  • The icing on the cake is reserved for the resident Indians. "RIBs are essentially for the bring-money-home market. It's an amnesty scheme whereby you take your idle money out and bring it back lily white; all done above board," says Atul Sud, MD, Strategic Capital. Under the scheme, resident Indians can jointly hold an account with their brothers, sisters, sons, daughters or even friends staying abroad. And actually gain from the falling rupee. "There's a mad scramble for unearthing long-lost relatives and friends. They can be gifted rupees in India for reciprocal dollar amounts abroad. And since the scheme is exempt from income, wealth and gift tax, nobody's complaining," says Tushar Shah of KBS Capital.
  • Bankers are happy too. SBI has undertaken to extend rupee loans to banks up to 50 per cent of the amounts mobilised at 9.5 per cent interest. Foreign banks can lend this money at a higher spread. Besides, in their fiduciary capacity, they can apply for bonds in their own name while holding them on behalf of their clients. Many banks are actually using NRIs as a front for their own investments in bonds. Arbitrage opportunities are aplenty.Investors can borrow in yen, convert it into dollars and invest in the scheme. Benefit: the liability continues in depreciating yen, while the returns are in the soaring dollars.
  • The government thinks itself the biggest gainer, procuring $3 billion in three weeks. "This was the cheapest, quickest, most viable alternative. No due diligence or policy changes needed, no marketing, handling or administrative costs involved," says Juneja.

    Some of this money may be laundered but as S. Venkitaramanan, ex-RBI governor, says: "Today funds transferred through the haw-ala route rest in Swiss bank deposits. The RIBs might bring some of these funds back to India. I don't see any incremental amorality in this." Concedes Jairam Ramesh, Congress general secretary: "Politically it's an astute move. A short-term, quick-fix solution to economic woes. But from the economic point of view, it's a disaster."

     First, the cost of funds is too high. Even at a conservative estimate of 8 per cent depreciation, the cost works out to be more than 17 per cent. Thus the cost to exchequer at repayment time would be phenomenal. The government may simply be subsidising banks and corporates down the line, feels Sanjay Bhasin of Standard Chartered Bank.Second, if such high-cost funds are deployed in core projects, where returns come in the long term, either the lenders would turn unviable or the projects themselves. Some analysts also argue that the money might not get into infrastructure at all because the payback is much longer than five years and no lender would risk a maturity mismatch.

    Third, the sudden forex inflow could whet inflation. "Once RBI gives almost Rs 12,000 crore in exchange, money supply will zoom. Considering that banks are already flush with funds, this might lead to a catastrophe in the long run," says one banker.

    RBI sources reveal that SBI will probably have a six-month swap at a market determined forward rate which will be rolled over. This will ease the pressure on the rupee which has been diving precariously. Once the forex flows in, the rupee might strengthen enough to ward off the global panic.

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