Counting on bonds

The Resurgent India Bonds scheme has pushed up the foreign exchange reserves to around $ 28 billion, but what will be its real cost?

THE overwhelming response to the Resurgent India Bonds (RIB) scheme, launched to raise funds from non-resident Indians (NRIs), has helped restore a measure of confidence in the resilience of the Indian economy, which is weighed down by a slowdown in industrial production, a slump in the markets, the free fall of the rupee against the dollar and mounting inflation, factors that were exacerbated by the economic sanctions in the wake of India's nuclear tests. The bonds, issued by the State Bank of India (SBI), generated $4.18 billion (approximately Rs.18,000 crores at the current exchange rate).

The RIBs had a coupon rate of 7.75 per cent and were meant entirely for NRI subscription. The scheme, open for 16 working days in August, attracted 74,300 applications. About 50 per cent of the subscriptions came from West Asia and South East Asia, while NRIs in the United States and Europe accounted for 20 per cent.

The RIB scheme's success has been viewed as a reiteration of the NRIs' faith in the Indian economy. But the jubilation cannot erase the fact that the money was raised on the sovereign guarantee of the Indian Government. For starters, the RIBs offered high yields (denominated in foreign currency) vis-a-vis other investment options available to the NRI investor. A coupon rate of 7.75 per cent in dollars (8 per cent in pound sterling for the United Kingdom and 6.25 per cent in Deustche marks for Germany) fully cushioned exchange rate fluctuation and offered a yield of two percentage points higher than competing investment options.

Reports that foreign banks vied with one other to lend money to NRIs to subscribe to the scheme confirm the impression that the bonds were an attractive investment. There have even been reports that the foreign banks themselves were the real investors and that NRIs were used as a conduit and paid commissions.

Analysts say that it is unlikely that all subscriptions were new and that nearly 12 to 15 per cent of the subscriptions have been made using funds diverted from existing Foreign Currency Non Resident (FCNR) deposits.

The SBI spared no effort to ensure success for the scheme. Forty-six Indian and foreign banks were designated as collection agencies and they were offered attractive incentives. Each bank will get back in Indian currency 50 per cent of the amount that it collected at a coupon rate of 9.25 per cent. This will give them a spread of up to 5.75 per cent at the existing interest rates in the domestic market. More than a third of the Rs.18,000 crores collected by the SBI through the RIBs is expected to be on-lent to the collection agencies in this manner. The SBI estimated that its collection cost amounted to 0.37 per cent. The cost of exchange rate cover was estimated at 1 per cent, taking the total cost of funds to 9.12 per cent.

There were reports that foreign banks offered attractive commissions and bore the travel expenses of subscribers who routed their applications through them. Among the non-SBI banks, Citibank emerged as the highest collector of RIB deposits. It collected $822 million through 15,000 applications at 23 offices in 15 countries.

The SBI intended to deploy the RIB deposits as follows: 27 per cent to meet Statutory Liquidity Ratio and Cash Reserve Ratio requirements; 25 per cent for the SBI's international operations (these will be used to pick up Indian paper abroad); and 40 per cent for on-lending to collection agencies. This will leave only 8 per cent at the SBI's disposal. Analysts estimate that the weighted average yields from all these deployments even after allowing a whopping 17.5 per cent return on the 8 per cent funds available with the SBI will just about equal the cost of funds.

No doubt the RIB deposits have pushed up the foreign exchange reserves to around $28 billion, an addition of 16.67 per cent. But a question that remains unanswered is whether it was worth adding this quantum to the reserves when there is no scope of earning a spread on deployment of the funds. Finance Minister Yashwant Sinha said that India raised the funds at a cheaper rate than countries such as Mexico and Argentina. This may be true, but what is of relevance is whether the deployment of funds ensures returns that justify the costs incurred on raising them.

The funds available with the SBI as well as those on-lent to the collection agencies are expected to be channelled into the infrastructure sector. However, considering that very few infrastructure projects are ripe for take-off, it is doubtful if the funds would be immediately absorbed. In fact, critics said that with excess liquidity in the system and a downturn in the economy, much of the funds will remain unutilised. Even if deployed in infrastructure, owing to the nature of the projects and their gestation periods what will be the returns that the SBI (and the agencies lending the RIB funds) can expect from such investments?

For the time being, the SBI has parked most of the funds in government securities. The Reserve Bank of India is auctioning more government paper worth Rs.4,000 crores to mop up rupees from the system so as to arrest its further depreciation against the dollar. Much of this is coming from RIB funds. Therefore, for the moment it appears that the RIB funds have found their way into the government treasury. What impact it will have on a profligate government is a sobering thought.