The Hindu Business Line : `New' instruments may have to be pegged to floating rates

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Chennai Jan. 26 While speaking at the FICCI a few weeks ago, the Finance Minister, Mr P. Chidambaram, rejected the industry's suggestion to allow it to replace high-cost rupee debt with seemingly low-cost foreign debt.

He said, "I cannot allow this as it would increase external debt of the country." The Finance Minister also announced that new financial instruments were being designed to attract and receive long-term NRI money into the country.

In this context, Business Line sought the views of Mr Robin Roy, Principal Consultant, Banking & Financial Services, PricewaterhouseCoopers (P) Ltd. Here are his answers to a few questions.

What are the cost differentials between Indian and foreign debt? What is the history of these controls?

The cost differentials are based on the following principle: Cost of foreign loans = Libor (london inter bank offered rate, which is a floating rate) + forex cover to protect against forex risk. Both are market determined.

Unlike the huge amount of money that the Government had raised from the global NRI (non-resident Indian) community where the rate of interest was guaranteed on the forex-denominated long-term bonds, State Bank of India which was the main distributor for this had to be subsidised by the Reserve Bank of India towards the exchange differential between that prevailing on the date of issue and the date of redemption.

Besides, increase in foreign debt can create inflationary pressures. Historically, due to modest exchange reserves, the Government did not have the leverage to allow for foreign investments or allow borrowings in foreign currencies.

However, the relationship between debt servicing of foreign debt and GDP (gross domestic product) needs to be watched, what with a significant amount of `hot money' coming in.

What can be the new instruments?

One historical example is what I just mentioned in the first answer. NRIs currently do not enjoy any additional interest rates vis-à-vis domestic deposits.

They enjoy protection from exchange fluctuation for all deposits placed with Indian banks.

Looking to the trends in interest rates, benign rates will not hold and there could be more frequent movements. Thus, new instruments would necessarily have to be pegged to some floating rates.

In order to encourage long-term investments into infrastructure there could be instruments like zero coupon bonds, with capital gains benefits. There could also be instruments which have call/put options at suitable intervals to provide the liquidity to the investor and allow the Government to respond if interest rates were to move unidirectionally.

Talking about banking, what is it that foreign banks can offer that Indian banks can't?

In terms of products, services, technology-based channels, Indian banks today can offer almost all of them. Technically, foreign banks can offer better-structured finance products with a diverse set of counter parties, including derivatives.

Due to their deeper risk appetite (not necessarily larger!) they have more proprietary treasury trading etc. However, some of the new Indian private sector banks have caught on and can offer similarly.

Currently, there are regulatory restrictions for derivative products applicable, to all banks operating in India.

More Stories on : Interview | NRIs | Forex

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