A V Rajwade: Mumbai as a domestic financial centre

WORLD MONEY

The number of cases of rupee-denominated bonds being issued outside India may well increase in future

Even as the report of the High Powered Committee on converting Mumbai into an international financial centre is being debated, I am wondering whether the city is in danger of losing its role as the premier financial centre for Indian companies to raise capital, and for trading derivatives based on Indian underlyings.

Some time back, there were a couple of rupee-denominated bond issues in the Indian market by multilateral institutions. One assumes that, to the extent the proceeds were not used for lending in rupees, the amount raised was swapped into US dollar to fund assets globally. In a little reported development, another multilateral institution, the New York based Inter-American Development Bank, has recently issued a rupee bond outside India. IADB would have approached the RBI for a rupee bond issue in the Indian market but has preferred London/Luxembourg because either it did not get a timely or favourable response from the central bank, or found the pricing overseas more attractive. Reports indicate that the AAA rated, three-year bond bears a coupon of 7.25 per cent which is well below the sovereign yields in India. One imagines that it was a rupee-denominated, dollar settlement issue. (Incidentally, the IADB issue is not the first rupee denominated, dollar settlement bond floated outside India. The first such issue was undertaken by GE in the 1990s, as a hedge against its exposure to rupee investments in India.)

From the pricing, one conclusion is obvious""there is a huge appetite amongst global investors for Indian debt instruments. To the extent we continue to limit the access of foreign investors to the rupee debt market, the number of cases of rupee denominated bonds issued outside India, may well increase, representing the "export" of a segment of our capital market. Bonds apart, would the Alternate Investment Market (AIM) in London become more attractive for floating IPOs by Indian companies? A number of real estate and entertainment companies have already accessed it. This is a potential threat to the investment banking services and stock exchanges in Mumbai.

The non-deliverable forward USD:INR market in Singapore and Hong Kong is of course well known and flourishing""given the size of deals that are reportedly put through, one feels that, measured by the impact cost, it is perhaps more liquid than the domestic forward market. Dubai is introducing a futures contract on the rupee, in other words an exchange traded version of the NDF. There is another, and growing, market abroad in derivatives based on Indian underlyings: credit default swaps with the reference entities being Indian companies. Apart from banks, hedge funds are also credit protection sellers for Indian CDSs. This market seems to be an obvious adjunct to the growing use of foreign debt markets by Indian companies, particularly through foreign currency convertible bonds. Such bonds are a combination of sovereign paper, a credit derivative, and an option on the equity of the issuing entity. Given the varying appetites of different players, they can take exposure to any of the three elements in the FCCB.

Overall, if the much-needed corporate bond market is to flourish, we do need to allow foreign investors in the rupee debt market without any quantitative restrictions and a market in credit derivatives in India.

In short, Mumbai is facing increasing cross border competition as a domestic financial centre. Its evolution into an international financial centre would take many more supporting steps, as outlined in the Committee's report. Without going into the political feasibility of many of the recommendations, I would like to make only one comment. Full convertibility of the domestic currency does not seem to be a sine qua non of an international financial center "" London was one for decades before 1979 when the currency became fully convertible with the abolition of all exchange controls.

Turning back to credit derivatives, the RBI has come out with a paper outlining draft guidelines for mortgage guarantee companies following the Budget announcement. Apart from the obvious contradiction in trying to introduce mortgage guarantee companies even while discouraging housing loans through monetary measures, I have some doubts about the economics. Given the proposed capital ratio, I imagine that a Rs 100 crore capital company would be able to issue guarantees for Rs 1,200 crore. Having regard to the administrative costs, such a company may need to charge a guarantee commission of perhaps 3 per cent per annum or so, in order to earn a reasonable return on equity. The economics will work only if the lenders are willing to charge interest at correspondingly lower rates for guaranteed loans. This does seem difficult given the cost of funds, at least in the current conditions.

Tailpiece: The freedom for Indian residents to invest abroad within certain annual limits has been there for some years now. Why the delay in the permission for marketing investment products?