Indian financial markets, says Dhananjay Sinha.
The only thing the four US banks in India know for sure is that the sanctions imposed by the Clinton administration prohibits them from lending to the Indian government. But there the certainty ends. Even as they scramble for clarifications from the US treasury department, it is clear that the economic embargo is likely to create more confusion for US banks than punitive measures for the Indian financial markets.
For the Glenn-Symington amendment that activated the sanctions raises other unanswered questions, some of which could mean an end to their operations in India. The biggest of them: what happens to US banks investments in government securities? Do statutory liquidity ratio (SLR) investments, a mandatory buffer that all banks in India have to maintain, also qualify for this ban?
Reserve Bank of India officials say they dont. SLR investments, they reason, are statutory and cannot be interpreted as loans to the Indian government. But if the US government insists otherwise -- since the investments have to be in government securities -- the American banks will face a crucial decision: not investing in SLR securities would disqualify them from operating in India.
Or, if US banks have to stop investing in SLR securities on an incremental basis they will not be able to accept additional deposits either, which can only mean the end of the road for them in India. Neither the banks nor the US administration are likely to want this, says a senior official of an established foreign bank in India.
Meanwhile, till the clarifications from Washington come through, US banks are understandably treading warily. Says a senior banker with a major European bank: "They will not be willing to take further exposure in Indian sovereign or corporate paper. At this juncture they will not want to invite any questioning on their lending or investments as they may attract cash penalties."
Indeed, this has seen many of the foreign banks selling excess SLR holdings in the market.The yields on the government papers have therefore soared. Last Thursday, two year government paper was quoting 200 basis points higher over the opening yield in the secondary market. And for the five year paper the yield rate jumped up by 150 basis points (see chart).
What could this mean? If the reactions are short term, as many bankers hope, the rupee and yields would come back to original levels very soon. Says Girija Pande, general manager, ANZ Grindlays Bank, "A lot will depend on diplomatic developments. It is important to see whether the Europeans and the Japanese will vote along with the US in imposing the sanctions. And things will get clearer once the budget is announced."
Even assuming the worst-case scenario -- that US banks in India do have to wind up -- the question is: how will they do it? Winding up operations would mean a complete transfer of their assets and liabilities to some other bank, implying big losses for the American banks. The question is whether the US banks will be ready to bear this kind of loss.
One consequence of this would be a reduction in the number of subscribers for the government borrowing programme. This would mean the domestic participants will have cough up more money to support goverment coffers.Indian banks say there is nothing to worry about. Says J Prasad, General Manager, of SBI: The total investment by foreign banks in government securites is not more than Rs 4,000 crore in a year. Compared to the total government borrowing programme of Rs 82,000 crore for 1998-99, this is a small amount. At the most, the interest rate will increase by only 10-15 basis points if we do not have the support of the foreign banks." If the embargo is limited to US-based banks then the impact will be even more diluted.
American banks could be losers in more than one ways. As PV Maiyya, CMD, ICICI bank explains, The absence of US banks will not make much of a difference even in the long run. There are many banks, especially European ones, that want to open up offices in India. And if the restriction on branch expansion by foreign banks are relaxed then I do not see any significant negative implication for the Indian financial sector as there would be quick replacement for the US banks doing banking business in India."
This view is also supported by others. Says a banker at an European bank that has opened its office in India recently: "While it is not clear how the US banks will react, the reduction in the size of their business will give us the opportunity to get aggressive and take over business from them. I do not think the withdrawal of US banks will affect the countrys macro-economics in any way apart from affecting their own bottomline."
Indeed, Indian banks that have bilateral overdraft facilities US-based banks have already started getting supporting lines of credit from banks from Britain, France and Italy. SBI which has the largest number of overseas branches in the US has committed $2 billion from banks from Britain, Italy, France and Belgium. In addition, to take care of the immediate shortfalls in dollar supply, SBI has at its disposal realisations from the GDR issues of public sector companies like Steel Authority and Mahanagar Telephone Nigam, apart from its own.
As for an expected currency turmoil, the central bank has indicated that it will strongly defend the rupee. It has indicated that it would roll back the intitial measures taken in the October credit policies towards capital account convertibility. Thus, it may disallow forward cover for investments by foreign institutional investors (FIIs) in government and other debt instruments in India. And it may also see such protection going on NRI deposits.
The threat of currency turmoil is limited even in the short term. According to ICICI Securities (I-Sec), the rupee is not expected to see any drastic loss in value. And with rupee resources drying up in the market the central bank has the option to initiate a cut in the cash reserve ratio. This will depend on the balance that the central bank wants to strike between stabilising the rupee and the auction of government securities.
There is little the central bank can do through the repos route even as the fixed repo rate at 6 per cent is well below the present call rate which is ruling at 9 per cent. The repos outstanding with the RBI has come down by Rs 10,000 crore to Rs 2,000 crore over the fortnight ending May 15. An I-Sec report says that unless the RBI initiates some measures the rupee is expected to stabilise below Rs 41 to the dollar.
Nor are FIIs unduly disturbed. They still a lot of promise in the Indian market. Says U R Bhat, director and chief investment officer, Jardine Fleming Asset Management, "We are not really bearish on the market. Top companies are not going to be affected by the sanctions. However, companies in the power and infrastructure sector may see some erosion. The negative spin-off is likely to be seen in the steel and cement sectors as well. But on the whole we are not going to be sellers".
On the negative side, the US accounts for 17.4 per cent of India's export and trade restrictions arising from sanctions may have some destibilising impact on the balance of payments front. Imports from the US constitute 10.6 per cent of India's total import. Trade restrictions will have limited impact on imports as thesse can be substituted from other countries specially from Europe.
Another area that could have a negative impact is project financing. Manyprojects in power and telecom sectors are supported by external credit agencies like the US Exim bank which mostly gives guarantees against project loans extended from US. Again, with the Japanese reacting in unison with the US authorities, funding from the Japanese banks which were comfortable lending to the Indian public sector, will dry up. "This is going to be a serious problem as these source of fundings will have to be replaced by commercial borrowings which will cost at least 100 basis points more compared to guaranteed loans," says a banker with a French bank.
Bankers agree that the bilateral funding programme from the US will take a severe beating. But the extent to which multilateral funding will be affected will depend on how much the US and Japan are able to influence these agencies in voting against India.
Already, the US adminstration has called upon the international finance agencies to act in its support. However, European bankers are of the view that despite US and Japan having large voting rights within the World Bank, IMF and IFC, it will be difficult for them to convince the world community for restrict multilateral finances into India.
