Home / Industry / Banking /  RBI planning changes to deepen bond markets: H.R. Khan

Mumbai: Harun Rashid Khan retired as deputy governor of the Reserve Bank of India (RBI) on Monday after almost a four-decade stint, handling portfolios related to financial markets, banks and monetary policy. Khan’s service at the central bank’s senior posts coincides with an era towards liberalization, of which 2016 would be the 25th year.

Harun Rashid Khan, 62Harun Rashid Khan joined the Reserve Bank of India in 1978 after completing his master’s in political science from Utkal University, Bhubaneswar, and a master’s in philosophy from the School of International Studies, Jawaharlal Nehru University, New Delhi.

In an interview, Khan said that the RBI is preparing to introduce a slew of changes to deepen the bond markets, something that has eluded the central bank for years. Khan’s advice to his successor is to be pragmatic, open to out-of-the-box ideas and maintain a balance between regulation and innovation. Edited excerpts:

Is there a growing impatience within RBI on the corporate bond market? Are big changes coming even as you sign off?

Let us accept few things. India like many other jurisdictions is a bank dominated market. Right now quality issuers of corporate bonds themselves are leveraged. We have restrictions on certain players such as insurance companies and pension funds for investment. We don’t have a functional trading platform similar to government securities and we have small outstandings of corporate paper. The tenure too is active only up to three years.

But I am happy to share with you that this is a discussion which is going on in the FSDC (financial stability and development council) sub-committee. A group has been formed and we are coming out with certain time-bound recommendations. So this is not going to be like previous reports by previous committees.

We have put it in a framework addressing what I like to call as the seven ‘I’s—issuer, investor, infrastructure, intermediaries, innovation, incentive and instruments. One major thing pending was the bankruptcy code which is now passed. The challenge would be to set up the infrastructure, an information platform, appoint judges and insolvency professionals.

The other area is re-issuance of bonds and having an integrated platform. Reactivating the credit default swaps (CDS) market is where a dialogue with market participants over the issue of netting is going on.

What about corporate bond repos?

Once this market repo picks up, possibly we will look at whether these corporate papers can be eligible for LAF (liquidity adjustment facility). We will have risk management parameters here.

Any other areas?

Other areas where we are working are on market making of corporate bonds. Exchanges will come out with a scheme on market making through brokers and these brokers can also be given access to market repos. We have already enabled banks and primary dealers. Primary dealers will be encouraged to do market making. Even credit rating agencies will be looked at. Another major area is credit enhancements. Here we are exploring to reduce the capital charge once rating improves. We are also exploring the possibility of allowing NBFCs (non-banking financial companies) more flexibility in giving credit enhancements, beyond the 20% allowed now. Also, going forward, as we have said in the discussion paper we put out, large corporates would be asked to fund some of their needs from the bond market.

Is there a case to hike the all-in cost for external commercial borrowings and make hedging mandatory?

All-in cost ceiling exist so that we don’t allow poor credit to borrow from overseas. In hedging, we are trying to move people to more long term and in rupees. We are also providing onshore hedging for offshore players like overseas lenders and investors. We did review the ECB policy. But now that we have set out a framework, we will allow at least one year for this to play out.

Has the RBI seen success in pushing for hedging?

I believe there is interest except on the currency futures side. But there is volatility also. It (hedging) has gone up from the 40% figure we gave last time. We can say that nearly half are hedged.

Is the forex market increasingly complex to manage and isn’t RBI intervention in exchange-traded currency futures against laissez-faire?

Complete free market is a myth even in the case of advanced countries. For us exchange rate and interest rate policy is very critical for stability. We certainly would like market to develop but whenever there is volatility, we would like to smoothen it out. Forex operations have indeed become complex. We have to up our antenna. Intervening in futures market was in the context of this complexity.

One of the point of nervousness in the market is the foreign currency non-resident (FCNR) deposits unwinding. Both you and governor Raghuram Rajan would not be around to monitor this…

The institution and the framework are there. There are contingency plans in place. As of now we don’t reckon a huge problem. What people fear is that exporters may not be able to roll over and that would create a mismatch. But exporters cannot perpetually roll over anyway. They have borrowed from the system and they have to repay. For us, rupee liquidity is under our control and we have enough reserves. But we will certainly monitor and be vigilant.

Would you also say that markets should not panic on the rupee depreciation?

Some countries panic on growth, some panic on employment, we panic on the rupee. I guess it is part of Indian psyche. There was a time when government officials would look at the screen and see whether the (exchange) rate is stable and only then approve any order. I think this sort of knee jerk reaction should be avoided. We have come a long way from that now. We have gained much more confidence now.

You have had the opportunity to work with three governors. Could you share with us the difference and the similarities you encountered?

All of them are Rs. Reddy, Rao and Rajan. So that is the similarities. On a serious note, all of them are great intellectuals. All of them guarded fiercely the autonomy of the central bank. All had lot of focus on data analytics and all of them were great gentlemen. Like the five fingers of your hand are different, everyone’s style of functioning is different. For instance, Dr Reddy was a thinker and he had clairvoyance and could see what will come. He can be very conservative on banking regulation but at the same time very liberal on markets. Subbarao was a great methodical. He had a very balanced view. Dr Rajan is very hands on. Normally academicians are not known to be hands on. But he is not a typical academician. He has a hands on approach in a variety of matters be it monetary policy, government, banking system or cash management.

All of them were consensus builders and had great faith in consultations. And each one of them had their own style of getting market information. I have enjoyed working with all of them.

RBI has been conservative in its approach to market development and rules. Does this conservatism still remain and has it paid off?

I think this description is not correct that we have been conservative. We have been conservative where it was required so. But we have been liberal and progressive in many ways. Take the last three years. Quite a few things have happened in terms of products and processes. We have tried introducing instruments. Volumes have gone up in the government securities market. Interest rate options are coming. What sceptics have complained is that there is no BCD (bond-currency-derivatives) nexus. But this is like putting cart before the horse. When all our markets are bank dominated, one has to do a balance in the trade-off between gradualism and big bang.

For a long time our bond market has not been completely open to the foreign players. Now we have a road map. I know it is not 20% or 30% for the bond market like other countries. But there are valid reasons why we should not open up completely. In fact, right now the conventional wisdom has been turned around and people are saying that capital account controls should be there. Even advanced countries are doing that, how can emerging markets (EMs) be completely open. The foreign currency volatility this entails has long term implications. But this does not mean we are not liberalizing or rationalizing. But I won’t say we have always taken the right call.

Is full capital account convertibility many years away?

So in 1997, we were talking and we were struck by the Asian crisis. Even in 2007, we discussed and then the global financial crisis happened. Now whether in 2017, it would happen? I don’t know. We may do a little more. Given the stability concerns, we have to be watchful. One area where we are working more is the internationalization of the rupee. But whether we need full scale internationalization itself is a debate not settled yet. This cannot happen overnight. People will need to accept the currency.

In the trade account we have allowed invoicing and settlement in rupees, we have opened the capital account a little more and have allowed more investors who have offshore exposure to hedge onshore. We will become international but for the rupee to become a reserve currency, it will take a lot of time.

Does the failure of masala bonds indicate we are not ready for internationalization of the rupee?

No, in this case there are other reasons. One is market condition. We have met few demands like reducing the tenure. A demand for exemption of withholding tax, for this the government has to take a call. The other is that Indian banks must be allowed to invest in these bonds. But banks have plenty of opportunity onshore and this will not serve the purpose of masala bonds. But when the market stabilizes, masala bonds should pick up.

You are leaving office when we are completing 25 years of liberalization. Any reflections, where you started off and where the RBI has come?

We have come a long way. We had a managed exchange rate and then we liberalized it to floating exchange rate. We had earlier a lot of capital controls. Our integration to the world has been achieved substantially. Unlike what people believe that we are a domestically oriented economy, our global integration is much higher now.

Whether it is in terms of growth or market depth or liquidity, quite a few things have happened since then. We have moved in a deep way and I recollect what Mr Seshan (T.N. Seshan, former chief election commissioner) used to say about LPG, that is liberalization, privatization and globalization. I think we have gone forward in all these parameters. It gives a good feeling that I have been part of this journey.

Any specific challenging moments where a big contribution was required from you as a central banker?

One immediate incidence is the 2013 episode when we introduced the FCNR (B) swap scheme. We had a lot of naysayers and people asked should the central bank compromise its purity in doing a market swap. But then there is one principle we followed and that is one has to be pragmatic and never say never. If the situation demands, one has to think out of the box and resort to unconventional methods. Of course, unconventional policies have now become the convention. We thought we will also look at things the unconventional way. The best estimate we got was that we would get about $5 billion from the scheme and were advised to not sully our image for such an amount. But we took the plunge and the rest is history.

The other area where I did contribute was in formulating the MSS (market sterilization scheme) in 2006 for sterilization. Much of the world was surprised that how the fiscal authority would agree to this. That credit goes to both governor Reddy and deputy governor Rakesh Mohan at that time. It also helped us in as much as we were running out of securities for OMOs (open market operations).

Another interesting thing is the way we purchased 200 tonnes of gold. It had to be done in a very secretive manner because it was price sensitive and we had to do this over 10 days and nobody got any hint. Only three to four people knew about this.

What are the three risks that you will want your successor to watch out for?

There are risks on which we have no control. The best defence is to have macroeconomic stability and we should not waver from the path of good policy, and fiscal consolidation. One has to be pragmatic and think out of the box. Third area is market developments. As we get more integrated with the world, we should get more confidence in opening our markets and providing access to more players. But always try to keep a watch on trade-off between regulation, innovation, freedom and stability. We need to also build capacity within RBI, I can say this being an insider. We need to get expertise in various verticals, and being a public entity we have to do this within the compensation limit. Close coordination with the government is also important as we cannot function in silos.

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