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Research:
Resurgent India Bonds

                                        Does it make sense for SBI to float these RIBs?

Firstly, it should be clear that SBI is just the front for the RBI/ Government of India. So, does it make sense for India to float these Bonds?

Mr AV Rajwade, Foreign Exchange Analyst, believes that the Bonds are much too costly for India (the coupons being much higher than warranted), that the expected increase of $ 1.5 billion in the country's Forex Reserves is not worth the cost and that the increased Money Supply that the Bonds' inflow will lead to will further fuel the already rising inflation rate. Refer to his article "World Money" in the Business Standard of Monday, 3rd August, 1998

Mr S Venkitaraman, ex-RBI Governor, in response to Mr Rajwade's article, feels that the Bonds are worth it, that the Monetarist argument about increased Money Supply leading to higher inflation does not hold and that increase in the country's Forex Reserves is a pretty good justification for the issue. In fact, he feels that "..If we orchestrate the drive carefully, we can raise as much as $6 to $8 billion - given a sufficient period of the bond on offer." Refer to his article in the Economic Times of Tuesday, 4th August, 1998.

The Government and the RBI are also looking to reap the "moral" advantage of the Bonds. Again, in the words of Mr S Venkitaraman, "The success of the RIB will be the best response to the global Jeremiahs who have written off India."

What do we feel? Looking at it purely from a business point of view, there is no doubt that we need capital. If it is available even at a slightly higher cost, (to offset psychological or invisible benefits), it might make sense to raise money when possible. The balance sheet of India Inc. should be able to absorb an increase in the country's foreign debt by about $ 2-3 billion. Remember, that the prospects for regular ECBs in 1998-99 aren't too bright. The important point, however, and on which there seems to be little discussion, is deployment and utilisation of the funds. If the government can really utilise the Bond proceeds for the purpose intended (infrastructure development), a virtuous cycle could be kicked off. The government's track record on implementing anything so far, however, has not been very encouraging.

We had heard something about the IDFC (Infrastructure Development Finance Corporation, under the chairmanship of Mr Deepak Parkeh) being involved in the deployment of funds, but nothing concrete has come out so far.



Win-win situation
Management gurus say that the best business deals are those which lead to a Win-Win situation for all concerned. The way the RIBs are structured, all parties stand to gain. Here is how foreign banks are using the Bonds to get cheap Rupee funds in India:

Banks are willing to lend money to NRIs to invest in the RIBs. In India, these banks will get Rupee funds to the extent of 50% of the amount raised at an interest rate of 9.5% p.a. That is, they get 5 year Rupees @ 9.5%, while yields on GOI debt for comparable maturity are in the region of 12.2%. The Economic Times estimates that the average cost of funds for these banks in India is in the region of 11.5-12%. The Prime Lending Rate of most banks for the corporate sector are above 14%. So, the banks, in effect get cheap Rupee funding by garnering subscriptions to the RIBs.

The balance 50% of the amount will be transferred to SBI's account, and SBI, in turn, will get Rupee funds from the RBI, at an undisclosed interest rate. Presumably, SBI will not be asked to pay more than 9.5% for such funds.

Gain to the Banks:
Commission / Brokerage 1.00%
Yield Difference in India (11.75% - 9.5%), assuming that yields on GOI paper will come down as a result 2.25%
Yield Difference on FX funds (after paying off the NRI) 0.25%
Net Earning 2.5% p.a. + 1% Commission

Gain to NRI (acting as front for Banks):
Share of Yield difference on FX Funds 1.25%

For those NRIs investing their own funds, the incremental benefit (over comparable instruments abroad) of investing in the RIBs, as shown earlier, works out to about 1.25% to 1.50% across the three currencies. An extra 1.25% for no extra risk. Talk about free lunches.



Effects on the Indian Economy
The immediate effect, of course, would be to put a cap on interest rates in India. Since about $ 1.5 billion to $ 2.0 billion is expected to be brought into the country, there will be infusion of at least Rs 8,000 Crores into the money market. The market believes, of course, that the RBI will immediately mop up this amount by floating fresh Government paper. The yield on such paper could, in all likelihood, be at least 50-75 bp lower than current yields.

Thus, a softening in interest rates across the yield curve is expected.

With Call Rates likely to remain soft, in the region of 5-7%, Forward Premia on the Dollar are unlikely to go higher than 8%. And with an addition of about $1.5 billion to the country's Forex Reserves, the sentiment for the Rupee should improve.

An important question is, "At what rate will SBI surrender the Bond proceeds to the RBI?" If the prevailing market rate is assumed to be Rs 42.50 per USD, it is unlikely that SBI will get Rupees at a higher rate (ie, at a weaker Rupee). Will it get Rupees at a rate lower than market (ie, at a stronger Rupee rate)? Macho considerations (of the "I love a strong Rupee" variety) apart, the exchange should take place at the market rate itself.

In other words, we would expect the Spot USD-INR rate to be largely untouched (except that it may strengthen a bit on account of any positive sentiment). The Money market and the Rupee-Dollar could see some softening in rates.

There would, of course, be an increase in Money Supply and the danger of higher inflation lurks.

The most crucial point is, how speedily and efficiently will the money be utilised for the purpose for which it is being raised.

There, all we can do is "Wait and Watch".



Links
Below are some Links and Resources on the Web, where you can download the Offer Document, the Application Forms, access FAQs and get more information on the RIBs

State Bank of India at http://www.sbi.co.in and http://www.statebankofindia.com
Hitesh Gajaria's columns at http://www.dhan.com/....Link is down
Bajaj Capital Ltd at http://www.bajajcapital.com

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