Govt may follow 1990s strategy to sell recapitalisation bonds: experts
Mumbai: The finance ministry is likely to repeat the 1990s strategy for selling recapitalisation bonds as it is considered less disruptive for government finances even as the bond market is expected to be the biggest casualty irrespective of the route that is finally chosen, say experts.
Bond yields rose on fears that recapitalisation bonds will add to the over-supply of government securities in the market. Yields on the benchmark 10-year government bond rose 3.6 basis points to 6.811%, a level last seen on 16 May.
One basis point is one-hundredth of a percentage point.
On Tuesday, the finance ministry announced a Rs2.11 trillion PSU bank recapitalisation plan, of which Rs1.35 trillion will be infused through recapitalisation bonds. The plan is spread over two years. The government is yet to release details on the structure of these bonds.
A. Prasanna, chief economist at ICICI Securities Primary Dealership, said there are only two feasible structures for issuing recapitalisation bonds. One, the government issues recapitalisation bonds to banks in lieu of banks’ equity. Second, a 100% government-owned special purpose vehicle (SPV) issues these bonds backed by the government.
At present, most public sector banks are stretched for capital, which is needed to not only meet regulatory requirements under the Basel-III norms but also to raise loan growth and resolve stressed assets. Indian banks are sitting on a pile of bad assets worth Rs10 trillion. The first method was used in 1990s when recapitalisation bonds were issued.
This route would be cash-neutral for the government but at the same time strengthen the equity capital base, which in turn would increase the leverage ratio and allow lenders to borrow more from the market. Stronger capital will also improve the credit profiles of banks and enable them to tap markets at better valuations, according to analysts.
The package also entails raising remaining Rs76,000 crore through budgetary allocation and from markets.
“The best structure would be these bonds not coming to the market like it happened in the 1990s. This will have limited impact on bond yields. In case of any other route involving bond sales by banks, the impact on yields will be negative, which would subsequently result in rise in borrowing cost for the government and corporates,” said Soumyajit Niyogi, associate director at India Ratings.
According to Reserve Bank of India governor Urjit Patel, except for the interest expense, recapitalisation bonds will be liquidity neutral. This expense will contribute to the annual fiscal deficit numbers.
The cost of issuing these recapitalisation bonds would be in the form of annual interest payment of Rs8,000-9,000 crore, chief economic adviser Arvind Subramanian tweeted.
Alternatively, the government can also allow banks to sell these bonds. However, such securities need to have an equity element. At present, additional tier-I bonds have equity-like features under Basel-III framework, which may not allow inclusion of other bond structures to compute capital adequacy.
Abizer Diwanji, partner and national leader-financial services at EY India, said that the government may have to put in some riders for these bonds so that they could be treated under the tier-I category. But this route would be challenging as there is limited appetite for tier-I bonds because of certain risky clauses they carry, according to debt market participants. Additionally, since the credit profile of each bank would be different, the interest rate will also vary and could add to government expenses.
The market is divided whether the government will give statutory liquidity ratio (SLR) status to recap bonds.
Prasanna of ICICI said that if these bonds are given SLR status, then it will impact government securities because banks’ incremental demand for government bonds may get diluted. “If the bonds are treated as non-SLR, then the impact won’t be on government bonds, but on spread papers likes state development loans, corporate bonds. Whichever way you look at it, there will be some impact on the bond market,” he added.
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