The Reserve Bank of India?s move to allow banks to hold non-SLR infrastructure bonds in their hold-to-maturity (HTM) category as long as the paper has a residual maturity of seven years is prima facie a good idea. However, it doesn?t take away the basic problem of an asset-liability mismatch because these bonds typically, would be of very long maturities of nine to ten years, while the average tenure of deposits that banks attract from retail customers, is much shorter, at less than half that duration.
Also, banks have been shying away from such paper because they were required to mark them to market or in other words benchmark the value of the paper to current market prices. That meant they might sometimes have had to take a hit which, understandably, they would not want. However, it?s unlikely that banks will be very eager to buy such long-term bonds simply because they are shielded from market prices for three years. In return for protection for three years, they may have to hang on to the bonds for seven years, if they cannot find a buyer and during that period, they will need to record the values of the bonds in their books, in relation to the market price. So, the deal is simply not tempting enough at a time when the corporate bond market is illiquid, especially for paper which is rated below AAA.
To sweeten the offer, RBI could probably allow banks not to mark-to-market the bonds until the residual maturity is five years. That?s not too short a period and hopefully, the corporate bond market would have grown by then. A glance at the data put out by Sebi shows that trading volumes in 2009-10 crossed Rs 4 lakh crore. That?s way above the Rs 1.4 lakh crore reported in 2008-09 and a four-fold increase compared to the volumes of just under Rs 96,000 crore in the year before that.
Trading volumes in the last three months of 2009-10 surged with the volume in March at a record Rs 67,000 crore plus. Foreign Institutional Investors have been lapping up Indian corporate paper and their quota of $15 billion is almost exhausted. So, the government?s reported initiative to raise this limit is a good idea. It?s a win-win situation really because companies need not borrow in foreign currency overseas but are nevertheless tapping the pool.
As for the FIIs, they are getting quality paper at good yields though they do need to pencil in costs for hedging their exposure. However, the spreads should be large enough to take care of the hedging expenses and leave them with good money. Of course, the Indian currency has appreciated by 12% over the past year or so making the returns on rupee-denominated debt even more rewarding for investors.
With interest rates likely to move up by anywhere between 100-125 points over the next year or so, investors in debt can look forward to better returns. The interest rate differential between the US, Europe and emerging markets, including countries such as India which have rebounded quickly and smartly from the downturn, is only increasing. That means the appetite for such paper will only increase, especially in a rapidly improving business environment which reduces the risk of defaults.