Bond standoff exposes flawed policy

The public debate over the change in policy governing perpetual bonds issued by banks underlines many an issue with policy choices and their implementation in the Indian regulatory landscape. 

While much ink has been spilled on the subject, a short summary of the situation would be useful. Perpetual bonds are essentially debt that do not have any specific date for repayment — i.e. they are perpetual and therefore akin to equity. Banks, as corporations are artificial legal persons with perpetual life and succession. Perpetual debt has to never be repaid by a specified date. The issuer of the bond has an option to “call” them back, i.e. exercise a right to repay. The option may never be exercised. Therefore, valuing these bonds is a tricky subject, particularly when household savings are exposed to these bonds through mutual funds. The Securities and Exchange Board of India (Sebi) has imposed a requirement to treat the bonds as being repayable in 100 years since issuance, to be able to compute the present day value of a debt due for recovery on a fixed future date.

This piece is not so much about what is the right way to value perpetual bonds as about how such serious change in regulation and policy choice ought to have been handled. Sebi is not wrong in expressing a desire to draw an empirical bright line for an outer limit, in order to be able to compute yields, and thereby value the bonds. The value of a debt due 100 years from today can be assessed objectively and empirically. Debt without a specific date of repayment would leave the valuation to market imagination. Indeed, volatile jerks in how they are valued could seriously hurt household investors in mutual funds, which in turn invest in such bonds.

However, when managing change, it is important to remember that the medicine cannot be more onerous and painful than the ailment. A medicine rejected by society would only hurt the patient more, no matter how vital the medicine may be. A sudden and immediate imposition of deemed 100-year tenure would overnight lead to the very same bonds having to be re-priced and revalued. The volatile change from how the market has been valuing the bonds until now to how it would be forced to value from now on, would inflict deep pain.   

The Reserve Bank of India is said to be mightily peeved. Every newspaper reported the Government of India’s desire to roll back the change as the lead story. It was primarily to ensure comity among financial sector regulators that the Financial Stability and Development Council (FSDC) was set up by law.  The idea was to ensure that never again would a finance minister have to announce that two regulators may resolve their differences in an appropriate court of law. So many methods of managing such a serious change could have been adopted.

First, a substantial legislative or policy change of this nature could well have involved pre-legislative consultations — a concept that is best used when perceived as a value system as opposed to a fetish to adorn glowing annual reports. Regulators praise themselves about how they conduct pre-legislative consulting but it is never an inviolable rule. Pre-consultations on such a drastic proposed change would have led to societal acknowledgement of the problem and emergence of acceptable solutions without a volatile aftermath. Reform by stealth, whether gradualist or with a Big Bang, underlines a lack of faith in the system to heal itself.

Second, the Government of India, statutorily wields the power to issue a direction on matters of policy to regulators under every economic legislation.  The existence of such substantive power is adequate to ensure that it never has to be formally used. That it is available is enough to ensure that a policy change that the government does not desire never even gets tabled for discussion. This is quite akin to veto powers in corporate articles where the person who wields that power would start expecting to be consulted in advance even while merrily claiming that the power to veto has never actually been used. It is therefore surprising that an issue of this nature has come to pass, without anticipation of the aftermath — one would never know the actual back-channel manoeuvres before the change got introduced. 

Third, a change as drastic as introducing a deemed mortality date for an animal designed to be immortal, could have been done with a combination of “grandfathering” and “transition” provisions. A grandfathering provision would mean a dual system, where the 100-year life would be applied only to bonds issued after the change. A transitional provision would address even that dichotomy to provide that existing bonds would have time (say 18 months or even 60 months) to move in parts to the new norm of valuation with the 100-year deemed tenure. Unless, of course, the gravity of the perceived danger from perpetual bonds already issued is so severe and emergent that grandfathering and transitioning would render the change meaningless. 

Contrary to popular belief, economic policy can be driven by ideology and dogma rather than articulated empirical reason. Hugging a corner of the ring and refusing to cede space or legitimacy to the other is an integral part of regulatory turf battles. With that approach, lasting change can remain elusive. Change by issuance of one fatwa can only last until the issuance of the next conflicting fatwa.

The writer is an advocate and independent counsel