Q&A: Jayesh Mehta, MD & Treasurer, Bank of America

'There has to be an attraction for individuals to invest in bonds'

India last week raised investment limit for overseas investors in local bonds. The authorities should review the withholding tax on overseas investment in local debt to attract long-term and stable investors as large sums of overseas funds are critical to fund the nation’s infrastructure, Jayesh Mehta, managing director and treasurer at Bank of America, tells Sumit Sharma in an interview. Edited excerpts:

RBI has raised rates for the fifth time this year, widening the interest rate differential with the advanced economies. What should India do to attract overseas investment to debt?
A higher limit is always welcome but if you want more long-term investors, you have to do something about the withholding tax. Long-term debt is quasi-equity and if you want long-term debt, you have to do something about this tax.

 

How much more overseas money could flow in following the increase in investment limits?
The government-security limits may get filled in soon, of course, subject to where the forwards trade. For corporate bonds, we need to resolve the withholding tax issue.

What challenges does India see from inflows, considering money is turning from the US and Europe to India? What’s your outlook on the rupee?
There is a considerable issue with inflows. They will continue to be a challenge for most central banks in Asia. From a macroeconomic view, managing inflows and inflation in a growing economy remains to be a challenge for central banks across Asia. The whole idea was turning the situation from surplus liquidity to neutral or deficit due to inflation. It is a challenging balancing that the Reserve Bank of India (RBI) will have to do.

In the short term, we expect the rupee to be in a range of Rs 2 either way from current levels. Our research forecast is for the rupee trading at 43.5 per dollar by March. Looking at inflation, we are not sure. India has a huge trade deficit, so we don’t see any dramatic changes. We don’t see much of an appreciation in the next six months by market forces, without much of an intervention.

India needs large sums of money to fund its infrastructure and corporate requirement. How critical is the need for active trading in corporate bonds in India? What is holding it up?
It’s not a question of money. It’s an issue of environment and structural situation. There are issues such as corporate bonds repo and refinancing against corporate bonds from central bank. I realise the second may not work. About 15 end-users constitute 75 per cent of the market. The rest 25 per cent is spread over 3,000 players across India.

This can change by two ways — by attracting more foreign investors, and removing or reducing the withholding tax to bring in more foreigners end-users. Another way is to grow mutual funds in the segment.

Typically, mutual funds don’t have long-term money in spite of tax break and there has to be an attraction for individuals to come for bonds directly or through mutual funds. The simple reason is that the deposit rates are so high that they are the most attractive rates in India, and are risk free. Worldwide, the deposit rates are Libor minus. In India, we have deposit rates Mibor plus 300 basis points or so. Changes in that will attract investors to come to debt directly or through mutual funds.

Of course, we have growing insurance companies and pension funds that are keeping the market stable. In spite of such a huge borrowing and mismatch between credit growth and deposit growth, the bond yields have not gone haywire. But they are end-users and not traders, so they can’t create liquidity. Similarly in corporate bonds, we are ahead of many countries in Asia. But for secondary trading we need players, for which we need a structural change.

How much of an impact will increase in rates by RBI have on bond yields and interest rates?
We are looking at the normalisation process and don’t see much of an impact. The focus here-on will be inflation and one could expect one more increase of about 25 basis points in RBI policy rates. I don’t see much of an impact on yields. What one finds disturbing is bank deposit rates. One will have to see whether deposits growing at 14 odd per cent and credit at more than 19 per cent are because of deposit rates or M3 money supply. It could be because of government not spending enough, but one needs to figure this out. Also, RBI is not sterilising foreign inflows is another factor. The banking system could be facing deficit of up to Rs 70,000 crore. Some banks have increased their deposit rates but will that increase deposit growth in the system, one is not so sure. If banks get into a deposit rate war, my forecast of stable yields will change. But as of now I don’t see that happening.

Where do you see 10-year bond yield by Dec-end?
If the deposit rate war doesn’t start, I see it below 7.75 per cent. I don’t see bond yields moving more than a quarter percentage point either way.