Mumbai: The spreads on the overseas credit default swaps (CDS) of Indian companies are steadily narrowing, indicating an improvement in the risk perception of overseas investors about Indian corporations.
According to CDS market trackers, the Indian economy’s robust growth, coupled with the central bank’s recent liquidity easing measures, signal that companies here are dependable—in terms of meeting their debt obligations—and that authorities here are ready to support the financial system.
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A CDS is a derivative instrument which allows traders to speculate on the borrower’s creditworthiness and ability to repay debt.
In typical contracts involving such instruments, the borrower makes periodic payments to the insurer (or seller of protection), who agrees to take on the risk of the borrower defaulting.
The “spread” or “fee” on this instrument indicates the amount the buyer of protection is to pay to the insurer over the period of the loan, expressed as a percentage of the nominal amount. Lower spreads indicate lower perceived risk of default.
In the 10-year bond segment, the CDS spread of Tata Motors Ltd, India’s largest auto maker by revenue, fell to 195.2 basis points (bps) or 1.952% on 16 December, its lowest since the credit crisis hit the global financial system in 2008.
A month ago the spread was 310 basis points.
Since 16 December, when the the Reserve Bank of India (RBI) left its key rates untouched and announced measures to infuse liquidity into a cash-starved financial system through an additional bond buying programme and the lowering of a bond holding rule in its mid-quarterly review of monetary policy, it has fallen further.
On 4 January, the spread was at 213.9 bps.
The spread on the same instrument was at 2,912.7 bps, or 29.127% of the nominal value of the bond, on 2 April 2009, when the credit crisis was gathering storm.
The spread on another company in the Tata group, Tata Power Co. Ltd, fell sharply a day after the RBI’s review of monetary policy was announced—from to 412.9 bps to 335.8 bps.
A month ago, the spread was 711.1 bps. The spread is now 319.6 bps.
Similarly, the CDS spread of State Bank of India, the nation’s largest lender, is now at 172.450 bps. After RBI’s December review of monetary policy, it fell to 174.075 bps from 185.225 bps a month ago.
The spreads of the other Indian firms in the 10-year CDS market—Bank of India, Exim Bank, IDBI Bank Ltd and Reliance Industries Ltd—have been relatively stable.
Alongside the Reserve Bank’s helping hand to the Indian economy, the narrowing of spreads can be related to the improved sentiment of the global economy.
“The main reason is the positive investment outlook regarding Indian firms,” said R.V.S. Sridhar, head of treasuries at Axis Bank Ltd.
“Globally, economies are recovering, while India is gaining investor interest as it is an emerging economy. The narrowing spreads indicate this comfort in India and its banks’ improved capital position, which are in a comfortable zone for overseas investors,” Sridhar added.
The Indian economy is expected to grow 8.5-9% in fiscal 2011.
The CDS spreads of Indian firms are trading at similar levels to that of their peers from Brazil, Russia and China—the four countries are part of the so-called Bric grouping.
The spread of Russia’s Bank of Moscow CDS, that has a credit rating of BBB-, same as the Indian companies, is at 330.600 bps now compared with 389.500 bps a month ago.
However, spreads on CDS of borrowers from the troubled peripheral euro zone economies are significantly wider.
The spreads of Hellenic Republic, the sovereign bonds of Greece, are currently at 912.610 bps against 798.520 bps a month ago.
“The overall environment in India looks conducive, while the (India’s) credit risk outlook is benign,” said Naresh Takkar, head of credit ratings at rating agency ICRA Ltd.
Rostow Ravanan, chief financial officer of software firm MindTree Ltd, said: “ The low CDS spreads help external borrowing (by Indian firms) as the market perceives low spread as an indication that the firms are likely to pay back the debt.”
According to Ravanan, the spreads are narrowing because the confidence in Indian economy is high and interest rates are low.