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Risk management of external borrowings will need greater attention

The second part of the excerpts from IDBI Chairman and Managing Director S H Khan's speech on 'Fingrowth: Financing India's Growth' delivered at a conference recently:

Corporate Debt Market

While the government securities market has, of late, seen some buoyancy, a vibrant and sizeable corporate debt market is still elusive. The secondary market trades in this category are very thin while market-making is at an extremely nascent stage. Consequently, maturities are mostly limited to 5-7 year range. In contrast, in the US market, maturities go up to 100 years for investment grade credits. With low interest rates and flatter yield curves, corporate borrowers there have been encouraged to extend maturities. Again, in the US markets, there is a trend towards bullet payments without call options. In contrast, most bonds in India with 3-year plus maturities offer put and/or call options as a proxy for liquidity in the absence of a liquid secondary market. There is thus a large agenda for action for Indian corporate bonds market.

As I see it, the Indian corporate debt market suffers from a combination of statutory limitations on various target segments like provident and gratuity funds to invest and trade in corporate debt, lack of flexibility in issuance programmes and onerous stamp duty imposts. These have stunted growth in this segment.

The reintroduction of repos on corporate bonds for periods even in excess of 14 days would introduce greater liquidity in the market, allow dealers to make markets and hedge positions. Further, the legal framework for securitisation of loans would have to be simplified to make it cheaper and easier.

Special purpose vehicles for purposes of asset securitisation should be recognised and regulated. Investment guidelines of long-term funds like PFs and insurance companies should be amended to allow them to purchase securitised paper.

A major impediment both to the development of asset securitisation as well as an active secondary market in corporate debt is the heavy stamp duty incidence at both ownership and turnover stages. These, in turn, vary widely across states.

I would advocate an urgent corrective in the form of a unified stamp duty imposition across states at reasonable levels on primary issuance of debt instruments and its complete elimination on secondary trading. This would reduce transaction costs considerably and give a fillip to both corporate debt and securitised volumes.

I support the removal of stamp duty on two counts: first, the revenue collection from these instruments has been quite modest so far; thus revenue loss from its abolition would be minimal. More importantly, trading in the secondary market is dominated by government securities and PSU bonds, both of which are exempt from stamp duty at the time of transfer.

In fact, there is a strand of opinion that corporate bonds should be dematerialised and allowed to be settled through the National Securities Depository Limited. The NSDL is facing problems in dematerialising corporate debt since, in an automated environment, it is difficult to keep track of such transactions and duties payable thereon. One solution is removal of stamp duties on transfer of debentures and NSDL be allowed to accommodate these instruments. Alternatively, a one-time levy or consolidated fee could be imposed by rationalising the stamp duty structure. This suggestion has come from no less a personage than the governor of RBI at a recent seminar and I do hope that participants at this conference will seriously consider this alternative and also suggest other measures to kick-start the corporate debt market.

Global Funding Options

I now turn to the external funding of prospective industrial growth in India. The cross-border sources of funds for corporates include foreign direct investment, global depository receipts, portfolio investment and external commercial borrowings.

From an official standpoint, FDI continues to be the most preferred mode of foreign fund inflows for obvious reasons. The policy dispensation continues to be positively oriented towards enlisting a larger quantum of FDI. It is particularly encouraging that FDI inflows in 1996-97 at $2.7 billion was the largest contributor to non-debt inflows in that year, the first time since portfolio investment started in 1992. I am confident that FDI inflows will rise to still higher levels in future, commensurate with the country's potential for such investments.

Investments by FIIs in the domestic debt and equity markets have been on an uptrend on the strength of strong fundamentals of the economy and investment incentives periodically announced by the government and regulatory organisations. The upgradation in post-trade infrastructure, the enlarged participation base in both equity and debt market segments, including almost all categories of government debt, announced in 1996-97 and, and more recently, the permission to hedge their debt exposures through forward cover are likely to give a fillip to these inflows in future.

There was a turnaround in the appetite for Indian GDR issues in 1996-97 as overseas market conditions improved. With India moving inexorably towards progressively greater convertibility on the capital account, there is likely to be a spurt in such inflows, along with ECBs, as blue-chip companies broadbase their sources of finance. But clearly, GDR markets alone cannot support large fund-raising programmes in future. Other options like the American depository market will have to be explored in a big way; indeed, a modest beginning has already been made by some corporates. This will require companies to prepare themselves for a separate set of specialised disclosure norms as well as different and more rigorous accounting standards.

ECBs are the other external financing option which has gained currency in recent times, with the serial liberalization of ECB norms and overall ceiling, particularly for infrastructure sector projects.

International financing of Indian industry -- both equity and debt -- is likely to continue as an important source in the future as corporates tend to find all-inclusive costs of foreign exchange loans to be somewhat lower than prevalent rupee interest rates. However, I must add a word of caution here that corporates, in the process, expose themselves to considerable risks of adverse currency movements and international interest rate volatility, especially on long-term loans or debt contracted on a floating rate basis. The recent volatility in exchange rates in India and the Southeast Asian currency crises have brought these uncertainties and adversities to the fore. An appropriate forex risk management will henceforth be central to corporate profitability, particularly with India opening up further on the external sector.

Forex Risk Management

Financing India's corporate investment intentions in the liberalised and deregulated era goes well beyond mere identification of cost-effective sources of corporate finance, both within and abroad.

The transition to eventual capital account convertibility (CAC) appears now an established fact although the phasing of the suggested measures may vary with the schedule that may be eventually drawn up. Among other things, the CAC would multiply the menu of risks which would need to be suitably identified, monitored and skillfully handled.

Both providers and users of money would now have to take on interest rate, liquidity, and currency risks arising from market factors. In the past, the administered regime largely precluded such risks. The duration risk or asset-liability matching would assume added urgency. It is imperative for financial sector players to effect a sea-change in their handling of risk-related aspects and assign it a primacy of place in their strategic responses.

The opportunity cost of inadequate risk appreciation can be debilitating. We need to draw lessons in this regard from the exchange rate crisis being faced by countries in Southeast Asia. The recent volatility in exchange rates, although meager compared to contemporaneous Southeast Asian currency movements, have made Indian corporates painfully aware of the cost of unhedged exposures, lulled by apparent stability of normal exchange rates in the recent past.

As Indian corporates and financial intermediaries access international markets for their funding requirements progressively in larger degree, they would be exposed to increased exchange and interest rate risk, necessitating use of risk management products. As a countervailing measure, there is a need for broadening and deepening of the money and long-term debt market in India. A rupee reference rate will bring into focus rupee derivatives in the market to address the interest rate risks.

I expect the discussions at the conference to bring out to other equally important aspects of forex risk management so that corrective measures can be initiated early enough into the CAC process.

Concluding Observations

To sum up, financing the emerging investment opportunities is both an opportunity and a challenge. From a domestic standpoint, a significant rise in domestic savings ratio and its channelisation into financial assets will crucially determine the domestic financing capabilities. Side by side, domestic capital markets and institutional infrastructure in the financial sector will have to gear up to be more responsive to emerging corporate requirements. The development of a long-term debt market, in particular, is a sine qua non for sustained financing of long-gestative, capital-intensive projects. Supplementary international fund-flows will continue to be aggressively solicited. This is likely to be attended by a greater attention to risk management products.

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