A Win-Win Deal?

Centre's debt buyback plan

K V KRISHNAMURTHY

CMD, Bank of India

It is obvious that high interest rates increase debt service costs. For a business enterprise, it is natural and logical to reduce its cost by prepaying its costlier debts by refinancing at the current rates.

Indian corporates have improved their bottom line by 43 per cent by mere reduction in the interest cost in the last financial year. Then why not government resorts to the same?

Surely it can, had it been forethought while raising debt.

In a falling interest rate scenario, the debt buyback scheme of the Centre exactly portends that, as it was not envisaged at the time of raising the debt to finance the deficit.

In case of corporates, the prepayment of debt is less complicated so long there is a prepayment provision in the agreement between lender and borrower.

On exercising the option, the borrower gains and the lender gets a prepayment penalty to off set his revenue loss, as the funds received could be deployed only at a lower rate.

The scheme envisages buy back of 24 stocks with a total face value of Rs 82,000 crore, carrying weighted average coupon rate of 11.92 per cent. All of them don't have any call option. To obviate the lack of call option, the buy back is made voluntary involving a transparent bidding process.

The moot point is "" would the banks get the funds on buy back. No, the high interest coupon securities would be substituted with low interest coupon securities, yielding in the rage of 5.50 per cent to 6.30 per cent, a win-win proposal favouring the government, as the interest cost saved would be about 5.50 per cent.

But why then the banks should take the scheme, when it is voluntary? The answer is, there are sweeteners in the scheme favouring the banks. The banks would get cash for the premium over the face value, albeit at a discount to the current market prices and tax break for the funds received.

But there is a rider, the tax exemption is available only when the gains received is used for non-performing assets (NPAs) provisioning. The rider translate into that the bank's operating profit would go up, but would not increase the net profit on account of this gains.

Then of course, the banks would show increased provision coverage for their NPAs and reduce reinvestment risk on short papers exchanged for longer maturities.

The benefit to the banks is qualitative, as their balance sheets would become cleaner. But it needs to be seen whether the buy back will be a win-win or no-win situation, from the banks point.

However it cannot be denied that, if the banks were to hold the securities till the maturity, a huge write off is imminent which can be pre-empted by exercising the option for buyback now.

The scheme would prompt an unwanted war of bids among the banks, in which the majority ownership rests with the government.

An unofficial cartel is a distant possibility. One-time settlement with a predetermined discount rate is a good option and would entail all the banks an equitable share of misery.

Above all, should the government become commercial and act like a Shylock?