De-personalising policy

This sort of coverage and reporting gets the goat of anyone. On August 18, RBI published the working group report on the development of a corporate bond market in the country. Some of the areas in which actions were due from RBI were announced a week later.

These decisions are announced by RBI but they are not taken by RBI alone and, even more importantly, they are not taken by the Governor alone. Hence, to announce these decisions as ‘Raghuram Rajan’s last hurrah’ does a disservice to others who were involved in the exercise from the Government of India, from SEBI and from within RBI and it also does a disservice to Dr. Rajan. It creates and breeds hostility, disappointment and anger in those whose contribution is ignored. Those in the government would be especially peeved. Dr. Rajan does not need their undeserved enmity either.

De-personalising and institutionalising policy changes are desirable and healthy. Newspapers and their journalists must play their due roles in that.

As the H.R. Khan Working Group Report states upfront, some of these things have been in the making for years, if not decades. The government made it already clear that these changes would be coming, when the Finance Minister delivered the Budget in February. In fact, the Working Group Report mentions the government announcements in the last page. Hence, what is happening is a Government of India policy initiative – long overdue – but which has been announced by the RBI. Most certainly not by Dr. Rajan in his personal capacity.

Now, as to whether these changes would herald the arrival of a corporate bond market with healthy liquidity is anybody’s guess. But, most certainly, they are desirable and they constitute the necessary conditions. Ultimately, the ball is in the court of companies that wish to borrow. In the developed world, financial markets’ are disappearing thanks to central banks. They have become the market. When companies place bonds privately with the central bank, the notion of a financial market place is risible.

This can, in theory, lead to better corporate governance and transparency in reporting. India’s accounting standards must keep pace with international standards even if they are more often breached rather than observed in the developed world itself. Who said that the developing world cannot set an example?  This document, released in June this year, says that Indian Accounting Standards have substantially converged with International Financial Reporting Standards but where there are ‘forbearances’ granted corporations, they can be removed and/or phased out soon.

To push and prod corporations to access the market, on the same day that RBI announced measures on the development of fixed income and currency markets, it also released the draft framework for banks’ large exposures to corporations and corporate groups. Once made into a policy, it becomes effective from March 2019. Since banks have to set aside more capital for exposure to a particular company or a corporate group, it dissuades banks from lending more, pushing corporations into the capital market to borrow. In principle, this is a welcome step.

Most of these developments would be greatly enhanced, as stated earlier, if corporations embrace the market as opposed to them continuing to hug friendly managers of majority government-owned banks. Further and equally importantly, if not more, the Statutory Liquidity Ratio of the government too must come down so that banks can direct their credit to medium and small enterprises instead of replacing loans to their corporate customers with Treasury bonds. Perhaps, RBI should come up with disincentives for excess investment in government paper. Another ‘large exposure framework’ document might be needed!

Andy Mukherjee had written that the new RBI Governor might act to discourage this tendency on the part of public-sector banks to seek the safety of government bonds whenever their non-performing assets begin to rise, choking credit flow into the private sector even further. It would be nice if the government co-operated. After all, SLR was needed at a time when the Government of India needed captive buyers for its bonds. A market might not have been available then. But, times have changed and how!

Today, with zero and negative rates of interest in the developed world, there would be ready takers for Indian government bonds that would carry a nominal coupon of 6% to 8%, depending on the Indian inflation rate. This situation will be with us for quite some time and even for quite a long time to come. Indeed, the problem may not be inadequate demand but too much demand, encouraging profligacy for a while only to ruthlessly punish much later and disproportionately. Financial markets are anything but linear. Otherwise, even as public debt in advanced economies leapt higher over the last four decades, investors would not have lent them at diminishing coupon rates!

But, as Dr. Y.V. Reddy, former Governor of the Reserve Bank of India noted in his book in 2010, financial markets do treat emerging economies differently. Therefore, it is important not to get carried away. Endorsement by Goldman Sachs is not the ultimate stamp of approval of sound public policies. These institutions lost their credibility long ago and have ceased to be benchmarks of excellence in their own spheres let alone be fair arbiters of public policy. The state of public disaffection for the central bank and financial institutions in the United States is proof of that.

All that being said, there is a case for substantial lowering of the Statutory Liquidity Ratio for Indian banks and even its total elimination within a reasonable time-frame. After that, it should become a normal credit decision for the banks to decide how much of their assets is held in the form of government debt – for trading and for maturity.

The private sector too and not just the government should be on guard against getting carried away by the demand for Indian paper. Again, there can be no doubt that ‘Masala’ bonds are a welcome development. It familiarises overseas investors with the Indian economy, Indian borrowers and with the Indian currency. India is internationalising quietly without much fanfare. That is to be applauded especially when offshore Renminbi deposits are dwindling and internationalisation of the Renminbi has slowed, if not reversed.

RBI in its circular has indicated that banks would be permitted to issue ‘Masala’ bonds (Perpetual Bonds or Perpetual Debt instruments) for meeting Additional Tier 1 and Tier II capital requirements. In theory, the exchange rate risk under ‘Masala’ bonds is borne by the investor and not by the issuer. In that sense, they are not ‘External debt’ strictly speaking. The currency of denomination of the debt is the Indian rupee. However, the currency risk is not fully eliminated. That should not be lost sight of. To the extent that the base currency of investors is not the Indian rupee, the exchange rate risk at a macro level for the country remains. If they take fright or if they decide to seek the safety of their own currencies for any reason, there will be pressure on the Rupee. So, ‘Masala’ bonds eliminate currency risk at the micro level but not at the macro level.

All told, there has been a quiet and steady onward march of right policy measures that slowly seek to enhance India’s potential economic growth rate and eliminate barriers to financing the enhancement of potential growth. From Bankruptcy code to GST Bill to Elimination of capital gains tax advantage to Mauritius-domiciled investors to reviving the corporate bond market, a lot is being done. Even as they deserve our unreserved praise, cautious counsel to stay grounded and focused on the tasks ahead would not be out of place.

(A modified version of this piece appeared in MINT on August 30).

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