Hitendra Dave, head of Global Banking and Markets for India at HSBC Holdings, believes it has become easier to market India as an investment destination since most risks associated with the country now emanate more from external factors rather than domestic ones. Even the redemption of FCNR deposits later this year should not impact the rupee-dollar equation, given the Reserve Bank of India appears to have covered its position over the past three years, Dave tells Bhavik Nair and Shobhana Subramanian. Excerpts:s
Is there a change in foreign investors’ perception about India?
The world is looking at India with far more optimism than local industry. I think the pessimism we have here hasn’t got to them. A lot of credit has to be given to the authorities—when the leader of a country, of the central bank or of the states go out there and say “come to my country, I will make things easier,” the message percolates.
But FPI money hasn’t come in at all this year…
FPI money is short-term. We should look at FDI numbers as well.
A lot of FDI is in e-commerce…
Who are we to judge what is better quality FDI. If it’s into e-commerce, how does it matter? The country needs a pot of money—if more of it goes into e-commerce, then local money can go into manufacturing. Everyone knows that there are certain things that need to be done for manufacturing. When your land prices are not materially different from land prices in larger markets, or with much greater purchasing capacity, you have a problem. Your cost of building a factory matches that of a rich Asian country or a poor European country, but your per capita income is still that of India. It’s not going to work that way.
What about appetite for Indian debt?
US yields have remained below 2% for a very long time. Absolute nominal rates attract people. In a fixed income market, people study what stage of the rate cycle you are in. In case of India, there is a sense that either we are in a long pause or there is more to go. Then they look at your twin deficits, and both are currently trending favourably. We can dispute whether 3.5% is real or not, but it is trending favourably. Yet another thing to look at is inflation, which has settled around 5%. If you are an international fixed income investor, you are looking for duration, for stability, for a country which is on the path of improved governance. Maybe the absolute level could still be debated, but I think there is not too much wrong. Today when I go outside India, it is easy to market the country. When people say what are your risks, you have to highlight a lot of risks outside your control—the US could raise rates faster than expected or you could talk about oil prices. But there are very few domestic factors. The only domestic factor that you need to mention is the rain god.
In fixed income, post hedging what are the kind of returns?
On a fully hedged basis, the carry is minimal—2-3%. As the hedging cost has gone up. The attractiveness of Indian fixed income market is that you keep it unhedged by and large. That is where stability indicators matter.
Do players tend to keep it unhedged?
There are two types. The real money long-only players prefer to keep it unhedged. Investments by prop books tend to be, most of the times, fully hedged.
How much volatility do you expect when FCNR swaps mature?
Rupee-dollar should be least affected by it. The fact that the rupee has gone from 60 to 67 in the last 15 months is the result of RBI’s hedging. Because RBI has done it over 18 months, one doesn’t notice it. But if RBI had done it in just one month, then wherever the rupee was it would have gone over 10%. So, this movement from 60 to 67 is not without basis. It is simply the result of RBI buying dollars through last three years or so. From a rupee liquidity and from a rupee-dollar perspective, there are no issues. There are some concerns on dollar liquidity because RBI will take full delivery of $24 billion, but many people, who have to deliver $24 billion to the banks to give to RBI, are unlikely to deliver.
Where do you see the yields now? Is the foreign money making some difference to the yields?
The fact that R2 lakh crore plus of your debt is effectively with a bunch of people who did not own it till five years ago—at some level, you have to say it has made a difference. That has been offset by the fact that the government’s (including states’) borrowing in the last 4-5 years has gone up equally large. But on a go forward basis, the biggest determinant of yield will be RBI’s target on liquidity conditions. When we had deficit, we had a definition which was 1% of NDTL. I think the neutral, on average, is the gap between the LAF number and the government balance with RBI, which should be zero. On the assumption that there are one or two more rate cuts to go and the liquidity conditions play out the way you want them to, that is LAF minus government balances should be zero on most days; then I think there is potential for 50-odd basis points slippage in the yields.
Is there a case for India joining JP Morgan bond index?
I don’t know. I am going against the grain of general thought on this. You can join an index today, but then you cannot have limits on foreigners. The debate is not whether we join the index or not. The debate is should we have no cap on the limit on our debt market? On paper and in an environment where we all have grown up benefiting from free market etc, you have to say, why not? But the reality is to consider it only when you know the domestic market has the absorptive capacity to take what the foreign markets can give you in a compressed time-frame. The nature of financial markets globally is that if it thinks you have done something wrong, irrespective of whether you think it is right or wrong, they will take, say, $30 billion back. Do you have a system which can soak up that supply in a quick time-frame? Because then it becomes a financial contagion. What is just a reflection of the views of 20 people will then reflect on the rupee/dollar, on the stock market, and create potential for macro instability. My sense is we should only come to that point when we have 100% surety in the depth of our market and that of our financial indicators.
Do you think there will be any action on domestic investors or banks being allowed to invest in masala bonds to enhance liquidity?
I hope not. We are struggling with liquidity. Why would you want to export it even more? One of the principle issues is the need for a pool of rupee liquidity outside India. We unfortunately have relatively small exports. Underlying if you want a local currency-denominated issuance to work in New York, London, Hong Kong, you need these pockets of rupee liquidity. There is none of these. In the absence of this, what you need is a strong view on exchange rates. When masala bonds were introduced, the rupee was at 64-65. Now it is close to 67. Even if I am pitching the product, somebody will say if I held it for one year, all I am making is 2.5%. For 2.5%, you want me to buy something which is inherently illiquid. For masala bonds we need a period where the rupee starts representing its fundamentals. Currently, the rupee is partly reflecting RBI’s keenness to keep building reserves and to make sure the currency is not getting misaligned from its peer group.
What do you think about the response for AT-1 bonds from India in offshore markets? Would it be feasible?
AT-1 is very close to equity capital and that has a cost. Today, a bank has to put down a marker for what it can raise as equity capital. There are two things. One, the cost is too high. The availability is also a question mark. Then you have to say, what can I get which is closest. That is how you compare. I am convinced that if AT-1 market for domestic banks has to evolve or take shape, it will have to be based on the domestic investor base. Say you are sitting in London or New York, there is a bank which comes there. They don’t know you. AT-1 are highly first loss kind of instruments. So, who will have confidence in those names? That has to come from people like you and me. It won’t come from international institutional investors. It has to come from the high net-worth individuals of India who have to believe that in the current stress scenario maybe I won’t get coupons for one year, but if it accumulates I will get it back in two years.
What do you expect from the next monetary policy review?
I think it will depend on Yellen’s meeting, progress on monsoon, full transmission of MCLR and some of the developments on what we call neutral liquidity. What I am looking for is he (Rajan) should reiterate the guidance on the interest rate stance, i.e. “I still remain accommodative.” Because a lot of people think he is done. That itself impacts yields. The system still needs lower borrowing and lending rates; not so much as policy rates. That comes through reaffirmation of liquidity. The second thing would be the reconfirmation that we are still looking for the space to do more.