The government has announced a large bank recapitalisation programme. Over the next 18 months, public sector banks (PSBs) are expected to get Rs 2.1 lakh crore of equity infusion through various sources.
Nature of re-cap bond
The government will issue bonds worth Rs 1.35 lakh crore to PSBs against equity shares. This then becomes a cash-neutral transaction (instead of a direct cash infusion). The government can also float a bank holding company, transfer all its shares in PSBs to this corporate entity, infuse some capital into this entity. This entity then borrows in the market against its equity as a AAA Quasi-Sovereign entity and uses the money to recapitalise the banks. This will require large legislative amendments.
Since upfront it’s a cash neutral transaction, fiscal deficit will be impacted only by the interest cost on the bonds that the government pays every year. Assuming at 7% coupon, the annual interest cost will be around Rs 9,500 crore. The government’s overall debt/GDP ratio though will increase to the extent of the bond issued and so will its repayment obligations. We expect the bonds to be longer dated, staggered over 10-15 years maturity and hence refinancing risks would be lower. Rating agencies should see this as credit positive for banks but credit negative for the government as the debt/GDP rises which is already very high for India as against similar BBB-rated countries. Rating upgrade chances would be pushed back but there will be some positive aspect as the financial stability of the banking system gets better. Most analysts will show the ‘reported’ fiscal deficit and then add these bonds outstanding as fiscal deficit including re-cap bonds.
Banks and recap bonds
Whenever the banks require liquidity, they can sell these bonds in the market, raise cash and use it for either lending or write-off purposes. In the current scenario, banks would likely hold these bonds on their balance sheet as part of the investment portfolio and earn interest on the same.
The RBI should be relieved on the plan as it increases bank equity capital to absorb the losses and to eventually increase lending. Also, the increase in fiscal deficit will not be inflationary, so it might support this plan of recapitalisation. But it has to make few key decisions which will impact the marketability of these bonds and its actual usage. The RBI will have to decide whether these bonds qualify as banks’ Statutory Liquidity Ratio (SLR). If it does, it will have a significant impact on the demand for government bonds and state development loans.
We assume that the government will put some restriction on the marketability of these bonds. Banks won’t be allowed sell all these bonds at a point in time. The off-loading will be staggered. If that is the case, then the banks would need Hold to Maturity (HTM) dispensation for these bonds. In fact, HTM bonds do not need to be marked-to-market for valuation purposes. Bank can then hold these bonds in the books without worrying about market risks. The RBI would though need to raise the HTM limit, which actually they have been cutting in the last four years.
Bond market impact
No SLR status, HTM limit dispensation and limited marketability is the most ideal situation as it will reduce bond supply in the market while keeping the demand for SLR bonds intact. Also since it does not directly impact the fiscal situation (apart from the interest cost) and hence it is not all that bad for the bond markets. But given that potentially there would be extra bonds in the investment portfolio of banks which they can sell to fund its credit growth, it will remain a concern for the appetite for bonds. Bond yields will inch up a bit but the overall trend still remains hinged on the fiscal situation.
The writer is head, Fixed Income,