One, Two, Three & Bingo! Lower Bond Yields & Stronger Rupee!

The ‘desperate’ monetary policy screams out the tough truth that the FM tried to mute in her budget speech.

The RBI's MPC announced the monetary policy on February 10. 

(Photo: Namita Chauhan/TheQuint)

Markets cannot be conquered or tamed or suppressed. Nor can they be silenced, as Finance Minister Nirmala Sitharaman discovered within hours of her ‘growth, growth, growth’ eulogy on Budget Day. She had hoped to put a lid on nervous bond markets, fragile rupee/dollar exchange rates, and spiralling oil prices by simply ignoring these critical variables in her short speech.

But the minute she dropped the debt bomb on the economy – government borrowing was going to leap by nearly Rs 5 lakh cr, a mind-numbing 50 per cent over the previous year – the dye was cast on the central bank governor. He had no option but to deliver a ‘desperate’ monetary policy a week later, screaming out the tough truth that his Finance Minister tried to mute in her budget speech.

The ‘Desperate’ Monetary Policy

I call the monetary policy ‘desperate’ because it tried every hook, every crook to avoid the inevitable:

• It held interest rates down for the tenth quarter running even as US treasuries quadrupled through that period, and oil prices nearly doubled

• The voluntary retention route (VRR) was hiked by Rs 1 lakh cr to suck in additional capital from foreign investors in the bond markets. Yields reacted by shedding ten odd basis points in an unconvincing ‘rally’. After all, what could a paltry Rs 1 lakh cr do when the finance minister had inexplicably declined to welcome nearly Rs 2.50 lakh cr ($30 bn) that would have gushed in had she altered the capital gains tax rules to permit India’s treasuries to feature in global bond indices. As missed opportunities go, it was the Queen of times!

• The rupee crashed beyond 75-to-the-dollar, and oil threatened to dance into three figures, which is always the most frightening choreography for India’s economy

But honestly, we don’t need to be so desperate or frightened. Just a couple of smart moves can significantly alleviate this stress – but for that, our Raisina Hill bureaucrats must stop cowering in irrational fears about dollar markets.

Act One: Boldly Go Forth With Sovereign Dollar Bonds

Remember 6 July 2019, when the same Finance Minister had gleefully announced a $10 bn issuance of overseas government bonds? But then, unfortunately, she scuttled it, scared by a volley of uninformed criticism. If she were to revive that bold idea, it would be a very prudent five per cent of the government’s gross borrowing programme and a mere one-and-a-half per cent of foreign exchange reserves.

In one stroke, she would move the foreign currency risk on to her fiscal accounts, spread joy in domestic bond markets, and herald lower local interest rates.

Of course, her Ministry will have to develop sophisticated foreign risk management skills to hedge the dollar and launch nimble treasury operations in international currency markets. Yes, it could be risky during times of capital flight. But precisely because it’s difficult and risky, it’s entrepreneurial, pregnant with exciting possibilities and gains.

Unfortunately, I can already hear the naysayers, but let’s debunk each objection one-by-one:

Objection: Volatile dollar/rupee rates will create “unquantifiable” costs in the long term

Counter: Wrong. By paying a premium of 5-odd per cent to hedge against future dollar rates, our costs will forever be controlled and quantifiable. While the hedged interest rate would be a few basis points higher than what the government could borrow at in local markets, these shall get compensated by the several positives that accrue on venturing overseas, including the fact that private borrowers get more cash in domestic bond markets

Objection: Why go overseas when FPIs (foreign portfolio investors) can now take Rs 1 lakh crore of additional rupee debt in the domestic market?

Counter: This one is specious. Because when you float a sovereign bond overseas, you access an entirely new category of lenders, over and above FPIs that are authorised to invest in India.

Objection: Foreign investors could indiscriminately dump our bonds, creating a run on the rupee and “importing” contagion

Counter: False. Since the bonds will be denominated in dollars and traded on overseas exchanges, any “dumping” would not directly impact the rupee or domestic markets. In fact, the alternative of increased FPI exposure to rupee bonds creates exactly the “dumping risk” that is being wrongly attributed to dollar bonds

Act Two: Sell Five Percent of LIC in Overseas Markets

While it’s yet to be firmed up, the Finance Minister virtually confirmed, by estimating her disinvestment proceeds at Rs 75,000 cr for this year, that she will sell only 5 per cent of LIC on NSE/BSE. Since LIC could be valued between $150-200 bn (Rs 10-15 lakh cr), the math is obvious.

But why is the government so under-confident about LIC’s IPO? I guess the rout suffered by two earlier insurance IPOs – GIC and New India Assurance, which wiped out over half of their IPO values - could be scaring the government. In any case, many also doubt the ability of Indian markets to absorb over Rs 100,000 cr in one shot. So, there is talk of breaking up the offer in two tranches of Rs 50,000 cr plus, ie, sell, burrp, and sell again.

LIC is Bigger Than China Life; So Why is it not Venturing Overseas?

Here’s a head-to-head comparison with China Life Insurance (Group) Company, the biggest in that country:

• LIC has nearly 3 million field agents vs China Life’s 1.8 million sales force channels

• Both companies have sold nearly 300 million policies

• LIC’s 66% market share is superior to China Life’s half-a-billion customers

• LIC’s market cap at listing is expected to be in the $150-200 billion range, higher than China Life’s $90-100 billion

• LIC will be listed on NSE and BSE in India; China Life is listed in Shanghai, Hong Kong, and New York

Now think a bit out of the box, think bold.

Why should we slice LIC’s offering into two tranches, separated by several months, simply because we are scared our local investors may not have enough appetite?

Instead, why don’t we sell half the issue in India, and simultaneously sell the other half overseas? That could raise close to $10 bn on LSE/NYSE.

Now do the arithmetic one more time:

• $10 bn from Sovereign Dollar Bonds

• $10 bn from the offer of 5 per cent of LIC stock on LSE/NYSE

• $30 bn from a tweak to the capital gains tax rules to allow Indian treasuries to list on global bond indices

Bingo! $50 bn flow into India, bond yields soften considerably, and the rupee appreciates against the dollar. No need for desperately silent budgets or monetary policies.