Floating NRI bond: A worthwhile idea whose time may not have come yet

The idea of getting dollars in is lucrative but the accompanying cost also needs to be considered

The first intervention of the government in steadying the rupee has been by announcing measures on ECBs, FPI and Masala bonds. Clearly the focus is on looking at enhancing capital flows. Quite expectedly this hasn't quite cheered the market and the rupee continues to fall due to external factors which no one has control over. The talk is now on having a NRI bond floated.

The concept of a NRI bond is not new and has been used in the past when conditions were desperate. These were in the form of the Resurgent India Bonds (RIB in 1998) or Millennium India Deposits (MID in 2000) which targeted NRIs. The idea is to get NRIs to invest in such bonds which give better returns than their domestic deposits which helps to garner dollars. Last time the RBI provided the swap facility on FCNR deposits which achieved the same purpose. Two issues arise here. First, is this necessary in the current context and second, will it work?

The forex reserves are presently at $ 399 bn which though just below the psychological mark of $400 bn is quite comfortable. Depreciation of rupee is more due to global factors which includes US' standoff with China, Turkey and Iran. These tensions will pervade the currency markets for at least another 3 months and the dollar will strengthen thus causing others to decline. No other country is planning such a measure and hence there is little justification for India to panic. Equilibrium will return albeit once the global market stabilizes.
 

If we do raise - say - $ 30 bn through such a deposit, it will shore up our reserves which have fallen by around $ 25 bn since March. This will definitely help to strengthen the rupee. However, the timing is essential. There will be a time lag between conceptualising such a scheme and implementation which could be between one to three months. By that time if the global conditions stabilize then the bond would have been unnecessary. Therefore, we need to have some thresholds on the level of forex reserves before embarking on such an exercise. This is so because all such bonds come with a cost.

The rate of interest that has to be paid has to be attractive and higher than that received on local deposits. With interest rates rising in the west, the cost automatically goes up. Second, there is the cost of hedging. Last time the RBI took on the hedge cost. If this is not done by the government or the RBI, then the issuing bank would have to take on this cost which will be high given the forward rates are in the region of 4.25 - 4.5 per cent. This is unlike a masala bond, where the forex risk is taken on by the investor. Third, these bonds have to be redeemed at some point of time which can be 3 or 5 years. There will be redemption pressure again at that point of time. The level of volatility in the market at that point of time will depend on the prevailing conditions.

Therefore, while the idea of getting dollars in bulk through the floatation of a NRI bond looks alluring, the accompanying cost has to be considered. Moreover, there is need for introspection to judge whether we have reached the point of no return. The fact that crude oil prices are going up which combined with a weakening rupee raised the antenna and evoked these thoughts. Presently, it may not really be required and while such plans can be made, one can wait for some more time before going through with such issuances.

The writer is Chief Economist, CARE Ratings. Views are personal