RBI governor talked about full convertibility recently. How far are we away from that?
The statement is reflective of the growing comfort that the Reserve Bank of India has about the macro situation. You would not have dreamt of such a statement two years ago with the chaos that was prevailing. The fact is, some of the improvement is structural...on the fiscal side, inflation side, and the current account deficit (side). That statement reflects the greater confidence of the RBI that the balance sheet has improved on a structural basis. For any genuine use, India is practically convertible.
Today you, and me can remit $150,000 a year. For a family of four it is half a million dollars. If you are a corporate, almost everything is liberalised. On the trade front, you are anyway fully convertible.
The capital account restrictions are not such there is significant difficulty. I don't see any implementation challenge per se. My guess is, if you see the sum of current account, plus fiscal, plus inflation, comfortable, at that stage if you have the confidence, you can do it. Beyond macro conditions, you need market conditions to have this convertibility. Bond and currency markets are still shallow.
What are financial market pre-requisites for convertibility?
Deepening of all markets is a desirable goal, and the governor mentioned it. There are forces put into place. For example, for exposures there are draft circulars on SBL (single borrower limit) and GBL (group borrower limit). One of the proposals is that there should be mandatory borrowing from capital markets for a certain percentage of working capital, and certain percentage of your term funding. The other idea is that your SBL and GBL have been proposed to be reduced. If the banking system is not going to lend, then you have to go to the capital market. On deepening, we are in a bit of a chicken-and-egg situation. If you open up, everybody will participate more. Currency futures and bond futures are available for everybody to trade today.
There are some structural impediments. On the rate side, you can sense the fact that our deposit rates don't move in an alignment with the policy rate. This is a subject of raging debate. That itself creates an impediment. Why would you buy a 10-year government security at 7.9% when you can get a one-year deposit t 8.25%, and you can break it on any given day? And, there is no cost to it. I won't say, unless market deepening happens, convertibility cannot happen.
What about the derivative markets in interest rates, and currencies? Foreign investors still prefer overseas markets?
As far as currency derivatives are concerned, it is a fact that none of us have grown up. You have to give it a long time. Forex is generally not a retail speculative product. Globally, people do not speculate on currency that commonly. Japan is an exception. When you say FIIs still access the offshore market, I think, it is time to study why they access the offshore market when they have access to much more liquid onshore. To the extent offshore price is cheaper, then you cannot do anything.
For example, in onshore, every time you book (a contract) there is a limit for cancellation, but in offshore there is no such thing. I think, it is time to make an inventory of activities that are exported because of regulations, documentation or just legacy and history.
We would soon have corporates issuing overseas rupee bonds. Would that change the way Indian markets are looked at?
IFC, ADB...these people have done successful rupee bond issues offshore. The next step is why not have Indian companies? The only people who would be interested in this is people who don't want to come to your country and register as FPI. And, everything gets exported out. More companies are issuing rupee bonds outside India and that activity could have been done easily here.
FII demand for Indian bonds has been soaring. There is a clamour for more. Do broader markets need higher limits?
It is best to assume that the compulsion to open up (hiking FII investment limit) is so low. If you compare countries, India's sovereign bond quota is not particularly small. We are comparable with China. Rather than having a sharp focus on how to make life easier for foreigners, I just hope they find equal reasons for domestic investors. Why don't you give the resident Indian a 5% withholding tax? It is about deeper local participation. Deeper and widespread local participation is your only hedge to foreign mood swinMarkets will become bigger. You cannot stop it. Your economy is growing. People in New York and London can say, 'oh the EM risk is off now'. I can never have EM risk off as an Indian. You should open up for FPIs in proportion to how much you manage to deepen locally.
Coming to monetary policy, the RBI seems to have reduced the expectations on rate cuts this year with higher inflation forecast?
The RBI has given certain inflation numbers....4% by August or 5.8% by March. There is a section of the market, which thinks the RBI has been far too conservative in this forecasting. That has been the case through 2014 when the actual inflation was significantly below the glide path. That is what the fixed income market is telling you — that the actual inflation numbers will be lower than the glide path.
Also, there is a section which believes that liquidity is not in sync with monetary policy?
The RBI stance on liquidity, at a level, is already reflecting that. They are leaving a lot of liquidity in the system. The system needs to have confidence that the deficit should come down to much lower levels. The system is still deficit but the extent of deficit has to come down by 30-50%. That is one way to measure the deficit.
The governor keeps highlighting the unhedged currency exposure of corporates. How do you reduce the risk?
Corporates that are not hedging are doing so on the only reason that you go out of India because of lower funding costs. Much of India's balance sheet is so stretched; then the purpose gets defeated. So, they have been taking on carry trade because they need to show some reduction in cost or some increase in profitability. For that they are taking this risk.
If the story ended there, nobody would have a problem. The problem is that when you have a 'taper tantrum' or when Yellen says something....it becomes a systemic issue. In 2013, July to August, there were companies which had not hedged; they came rushing to hedge. It creates dollar demand when you don't need it. This is where accounting issues come in. You don't need regulations. Just bring accounting norms. Be at par with international norms. You will at least be able to manage the risk. Rather than forcing companies to hedge or force banks to have higher capital, we need better accounting practices.
How do you see the Governor's effort to get retail investors into the G-Sec market?
For getting long-term capital gains, do FPIs have to hold on for 3years? They do not have to. Why should the resident individual have to do so? It is a funny situation where a resident individual is treated on inferior terms. Then comes the tax issue.
India has a situation where deposit rates are above policy rates. In most parts of the world, deposit rates are at par or below the policy rate. You can't change the deposit structure. If you are willing to say 5% withholding tax for international investors with no additional income, offer the same to resident Indians. You will create a much greater base.
