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RIB poised to 'create a new benchmark for sovereign borrowing'

Karsan Sippy in Bombay

Resurgent India Bond: At a glance *Targeted amount: $ 2 billion *Launch date: August 5 *Issue open for: 30 days *Earliest closure: August 17 *Roadshows kicked off on: July 26 *Coupon: 7.75% on dollar fund, 8% on pound sterling and 6.5% on DM (payable half-yearly) *Tenure: Five years *Minimum amount: $ 2,000, DM 3,000, pound sterling 1,000 (thereafter multiple of $1,000, pound sterling 500 and DM 1000) *Tax benefit: Exemption from income tax, wealth tax and gift tax *Salient features: Principle, interest repatriable; premature encashment in non-repatriable rupee after six months; joint holding with resident Indians allowed; transferable freely between NRIs subject to registration with SBI; can be donated or gifted to Indians only once -- not transferable thereafter; no listing on stock exchanges and hence no trading.

The State Bank of India, the country's largest commercial bank, kicked off the roadshow for the Resurgent India Bond -- RIB -- on Saturday, July 25, at Dubai. Over the next ten days, seven teams of SBI Caps -- the lead arranger to the issue -- will crisscross the globe hawking the five-year deposit to non-resident Indians and overseas corporate bodies. The issue will open on August 5.

In the first leg, one SBI Caps team will hold roadshows at Abu Dhabi, Bahrain, Kuwait, Singapore, Hong Kong, Bangkok and Jakarta -- the hub of NRIs. Parallel roadshows will be held in London, Frankfurt and Paris selling the five-year deposits denominated in dollars, pound sterling and deutsche marks. The dollar deposit will carry a coupon of 7.75 per cent, pound sterling 8 per cent and DM 6.25 per cent.

"We are yet to chalk out the detailed schedule for roadshows. It has been decided that about seven teams will hawk the issue to NRIs across the globe barring those places where local laws do not permit pre-issue campaign," says SBI Caps managing director A R Barwe.

For instance, the SBI Caps team will visit South Africa to meet NRIs, but will not be able to hold any roadshow because of local regulations. Another likely "trouble spot" is the United States where the regulatory authority -- the Securities and Exchange Commission -- has not yet given the green signal. "We are expecting the clearance this week. One team will visit New York, Washington, Chicago, Los Angeles, San Fransisco and San Jose, and another Pittsburgh and Canada," Barwe said.

The RIBs will be eligible for investment by NRIs, OCBs and banks acting in a fiduciary capacity on behalf of NRIs and OCBs. Both the principal amount as well as interest-payable half yearly or on a maturity basis on maturity are repatriable for NRIs. The face value of the bond will be $ 2,000 for dollar denominated instrument, 1,000 for sterling bonds and DM 3,000 for deutsche mark bonds.

Premature encashment of the bond will be permitted in Indian currency after six months for the date of allotment without any penalty. The NRIs will be able to jointly hold the bond with resident Indians. The instrument -- which could be gifted to resident Indians -- will be transferable between NRIs and OCBs. The bonds will be exempted from income tax, wealth tax and gift tax. The tax benefits will be available to the donees as well as transferees.

SBI chairman M S Verma said the RIB proceeds will be used to back infrastructure financing at a cheaper rate.

The Centre will charge the bank a "nominal" guarantee fee to bear the exchange risk for the foreign currency bond which will be shown in the SBI books as "other liabilities".

SBI will not incur any loss on account of depreciation of the rupee. While the Centre will bear the exchange risk, the guarantee cover will be shared equally between the bank and the borrower. The cost of the guarantee will be factored into while fixing the lending rates for infrastructure projects, Verma clarified.

Without referring to the adverse impact of economic sanctions and the possible complications in raising resources in the US, the SBI chairman said: "Even if one country does not accept the notification (for the issue), we will not constrained by it. If there is problem in one centre, an alternate arrangement can be worked out."

According to the SBI chairman, the bond will enable the bank to lend at about 13 per cent for the infrastructure sector as the cost of five-year money will work out to around 9.2 per cent. In contrast, the term lending institutions have been raising five-year funds at a cost of 13.5 per cent.

"We will insist on disbursing rupee funds. In case the corporates want the forex fund, they will have to bear the exchange risk. The major portion of the bond proceeds will be brought to India to be disbursed in Indian currency," he said.

Ten foreign and four public sector banks have bagged the mandate to sell the RIBs to NRIs and OCBs.

The ten foreign banks are ABN-Amro Bank, Abu Dhabi Commercial Bank, ANZ Grindlays Bank, Bank of America, The British Bank of Middle East, Citibank, Credit Lyonnais, Deutsche Bank, Hongkong Bank and Standard Chartered Bank.

The list of public sector banks includes Bank of India, Bank of Baroda, Canara Bank and Punjab & Sind Bank.

These banks will earn a 0.25 per cent service charge and a maximum brokerage of 1.5 per cent on a graded scale. In addition to that, they will be entitled to access rupee funds to the tune of 50 per cent of the collections, or a sum decided by SBI -- whichever is lower -- at a cost of 9.5 per cent.

These 14 banks have given a commitment to raise between $ 10 million and $ 150 million. Besides, 20 other banks will act as sub-brokers. These banks will not get service charges.

Some of the foreign banks are believed to have launched an ad blitzkrieg in the Middle East, wooing NRIs with loans to invest in RIBs. "They are ready to extend loans at 75 basis points over Libor to NRIs to invest in RIBs. The investors can make a spread of about 150 basis points by arbitraging between floating rate loans and the fixed rate RIBs," banking analysts said.

By being the collecting banks, the foreign banks will also have access to cheap rupee resources which they can deploy in India as SBI has committed to place 50 per cent of the collected amount at 9.5 per cent. "Without the exchange risk, the foreign banks will get five-year funds at a very cheap rate," analysts pointed out.

The J P Morgan report on Resurgent Indian Bonds says the Centre will end up spending Rs 8 billion towards the exchange risk of a corpus of $ 2 billion if the annualised depreciation of the rupee is pegged at 6 per cent. The cost of this "subsidy" is quite high considering that a significant portion of the RIB may not even create any additional inflows, it said. The total ''incentive'' is even higher if the hidden cost of tax exemption were to be added.

Dwelling on the "extent of incentive/subsidy provided by the government to make the rupee cost affordable", the report said assuming SBI creates rupee assets out of the dollar liabilities to the tune of 50 per cent and annualised depreciation of 6 per cent, the cost of the exchange risk works out to $ 9.48 million on every $ 100 million raised. However, faced with sanctions, declining investor sentiment and a Moody's downgrade, incentives for such an issue could be many, it said. The float will help in shoring up forex resources, ease the pressure on the country and aid domestic liquidity. It might actually result in reverse capital fight (in form of gifts from NRIs), it said.

Even though the government would need to provide "subsidy" only to the extent SBI creates rupee assets out of the dollar liabilities (rupee loans), it will by no means be small, it said.

Barwe of SBI Caps countered the J P Morgan argument saying: "If you take into account that the annual depreciation of the rupee is about five per cent, these are cheap five-year funds. The RIB will create a new benchmark for sovereign borrowing."

The JP Morgan report pointed out that the issue provides an excellent opportunity for investors especially for rupee returns. The residents can get tax-free rupee returns of up to 19 per cent.

The illegal foreign exchange market is excited about the RIB. The bond offers the biggest money laundering opportunity since the highly successful India Development Bond issue of 1992, hawala market sources said.

Hawala market operators and brokers in Bombay have been flooded with enquiries since the announcement of the issue. The modus operandi is as follows: Somebody wanting to whitewash his unaccounted wealth takes the fund out of the country through the hawala route. He enters into an agreement with an NRI/OCB to subscribe to the bonds and gift the bonds back to him. Presto. The money comes back clean and cheap. RIBs are allowed to be gifted and are exempt from gift tax, wealth tax and income-tax.

The cost of the entire operation will work out to less than 5 per cent, which is considerably lower than other money laundering options currently available. The only hassle will be the initial six-month lock-in period. After the first six months, RIB can be redeemed at a discount to the full-term coupon rate.

Hawala operators' successful experience with the IDB is luring them to take greater interest in RIB. Money launderers made a beeline for IDBs from NRI investors and sold it in the domestic market for a premium, which reached as high as 20 per cent towards the last few weeks of the redemption date.

According to market sources, this experience may lure hawala operators to invest directly in RIBs without waiting for money laundering requests from resident Indians. They could then sell it (gift it) at a premium in secondary transactions, like what they did for IDBs by collecting the bonds from NRI investors.

One cause of worry for hawala operators is the extent of immunity from disclosures under different taxes for the receivers of gifts of RIBs, though the scheme is free of wealth, gift and income taxes. According to sources in the income-tax department, the assessing officer is empowered to seek details from the taxpayer about the RIBs he had got as 'gift'.

"We can also write to the NRI or the overseas sources who have gifted the bonds to satisfy ourselves," sources said, adding that any abnormality including substantial gifts will always be prone to investigation.