India cautious on offshore rupee growth
Chastened by the 2012 volatility, Reserve Bank of India officials strike a cautious note about the virtues of rupee internationalization, as efforts to launch several offshore rupee bond issues gather pace. Market participants warn that liquidity and exchange-rate risk looms large on attempts to push greater usage of the currency abroad.
Indian prime minister Narendra Modi, with David Cameron, announced a bond issue in his visit to the UK in November
The Reserve Bank of India (RBI) allowed offshore rupee or Masala bonds in 2014 when the International Finance Corporation and the Asian Development Bank issued rupee-denominated debt in London, setting a benchmark yield for such instruments.
Then, in September this year the central bank published guidelines for Indian corporates and banks to issue rupee debt abroad.
In his recent visit to the UK, Indian prime minister Narendra Modi announced a bond issue by the Indian Railways in London in the coming months.
Housing Development Finance Corporation (HDFC), India’s largest bank, announced a $750 million issue along with public sector firms including the Power Finance Company, the Rural Electrification Corporation and the National Thermal Power Corporation (NTPC).
A senior official of the RBI spoke to Euromoney on the condition of anonymity, as the RBI is not discussing this issue with the media.
As India has performed relatively well compared with other emerging markets, he said there is greater demand for rupee-denominated assets, not just from fund managers but also central banks and sovereign wealth funds that desire diversification into the rupee.
In a May 2015 speech, G Padmanabhan, executive director of the Reserve Bank of India, stressed the need for capital-account convertibility as a crucial initial step in internationalization of the currency.
Padmanabhan, who has since retired, said that capital-account convertibility and the development of offshore centres are enabling conditions for internationalization.
The RBI official says the central bank is not looking at allowing offshore trading in the rupee anytime soon. The central bank, he says, is looking at a sustainable improvement in macro-economic factors – such as the fiscal and current-account deficits, inflation and GDP growth – before looking at promoting greater trading of the rupee offshore or stepping up capital-account convertibility.
“As long as the rupee is not fully convertible on the capital account, we would not like to make the rupee a traded currency and instead facilitate the usage of rupee in real transactions,” he says.
“Any opening up of the capital account needs to be accompanied with strong and sustainable macro factors that will add to the overall strength of the rupee instead of causing a capital outflow.”
Although marred by volatility in 2012 and 2013, the RBI has taken consistent steps toward liberalizing the currency. A rupee-settlement trade mechanism was approved in 2012 allowing domestic traders to invoice in the rupee. The onshore currency derivatives market was opened to foreign investors in 2014 to allow hedging for rupee exposure.
The official added that, at the moment, investment demand for rupee assets is far greater than its demand in real transactions. In the past year, he says, the usage for the $51 billion quota for foreign investment into the domestic corporate bond market has shot up to almost 80% after years of under-use.
However, he says the scheme to allow rupee invoicing for trade remains unpopular despite the “back-to-back hedging facility provided to banks”.
Renu Kohli, former RBI
Renu Kohli, a Delhi-based economist and former official at the RBI and IMF, respectively, says growth in international usage of the rupee is not sustainable when driven by financial transactions alone; volumes, depth and motivation to hold a currency arises from trade-based transactions. She says progress in real-sector reforms has begun to lag financial sector reforms in some dimensions.
According to the most recent foreign-exchange survey in 2013 by the Bank for International Settlements, the rupee ranked 20th in terms of global turnover totalling $50 billion daily or 0.9% of global transactions. This is down five ranks since 2010, when efforts around the internationalization of the rupee began in earnest.
Rakesh Garg, managing director and head of global finance for Barclays’ investment banking division in Mumbai, is part of the team that is roadshowing the HDFC and NTPC issues in London and Asia.
He is enthusiastic about the prospects of this market, even though he acknowledges some initial investor concerns about the liquidity in the instrument.
“As for any new product and market, this market will gain momentum as an increasing number of investors and issuers come into this market,” says Garg.
He says most investors looking at investing would be outright currency players and given the substantial pick-up in yield expected in these bonds, they are unlikely to hedge for currency risk.
Garg estimates, without the withholding tax requirements, yields to be slightly inside of onshore yields for similar credits.
“These investors are clearly looking for rupee exposure,” he says. “But even if the currency doesn’t appreciate, a stable currency will ensure a significant yield pick up over dollar yields.”
As India’s current-account deficit has shrunk from 1.6% last year to 0.2% of GDP this year, most investors are not expecting a drastic depreciation of the rupee, adds Garg.
Kohli is more cautious about the exchange-rate risk since the regulator has a part to play during bouts of currency volatility.
However, she says the RBI’s new inflation-targeting regime, adopting in March, will go a long way in assuaging concerns around the lack of transparency in the RBI’s monetary policy.
“The implication that the value of the rupee will not be undermined is important because a lot of the corrections are driven by investor perceptions of risk and uncertainty,” she says.
“This will assist in greater pick-up of the rupee abroad, which will then give additional reasons for policymakers to take macroeconomic stability much more seriously than they would’ve done in the past.”