Recap bonds likely to raise debt levels, push back rating upgrade

Radhika Rao, Economist (group research), DBS Bank, said, interest paid on the recap bonds might push up the Centre’s revenue expenditure. “But it is also possible that the issuance is structured such that the headline fiscal deficit is left unchanged but will raise government debt levels,” she said.

Tuesday’s recap measures are encouraging but certain aspects require clarity, Rao said. “Details on the exact nature of the recap bonds, duration, size, issuance details and interest rates pegged to the instrument. Bank reforms have also been promised, but details have been scant. For now, odds of consolidation and M&A in the banking sector are low. Impact on this year’s fiscal math is also under question,” she said.

India’s debt-GDP ratio was 67.9 per cent in 2016-17. NK Singh panel had proposed bringing it down to 40 per cent for Central govt and 20 per cent for state governments by 2022-23.

As the recap bond is a cash neutral transaction, the fiscal deficit will be impacted only by the interest cost on the bonds that the government pays every year. Assuming a 7 per cent coupon, the annual interest cost will be around Rs 9,450 crore. “We expect the bonds to be longer dated staggered over 10-15 years maturity and hence refinancing risks would be lower,” Chari said.

Analysts said the government will put some restrictions on the marketability of these bonds. “Banks won’t be allowed sell all these bonds into the bond market at a point in time. The off-loading will be staggered. It that is the case, then the banks would need HTM (Hold to Maturity) dispensation for these bonds. HTM bonds do not need to be marked-to-market for valuation purposes. Bank can then hold these bonds in the books without worrying about market risks. The RBI would though need to raise the HTM Limit, which actually they have been cutting in the last 4 years,” Chari said.

On the market impact, Chari said said the SLR (statutory liquidity ratio) status, marketability and the HTM issue will be crucial factors. The absence of SLR status, HTM limit dispensation and limited marketability is the most ideal situation for the bond market as it will reduce bond supply in the market while keeping the demand for SLR bonds intact. Given that potentially there would be extra bonds in the investment portfolio of banks which they can sell to fund its credit growth, it will remain a concern for the appetite for bonds. “Bond yields will inch up a bit but the overall trend still remains hinged on the fiscal situation,” he said.

The RBI will have to decide whether these bonds qualify as banks statutory liquidity ratio (SLR) — which is the portion of deposits (currently 19.5 per cent) to be parked in government securities. If the RBI allows SLR status, it will have a significant impact on the demand for normal government bonds and State Development loans which qualify as SLR that the government’s issue to fund their fiscal deficit. UDAY bonds, issued to revitalise power distribution companies, do not have SLR status.

Such bonds were tapped in the 1990s under which the banks sold their shares through a rights issue to the government, in return for such capital support. “Such recap bonds have also been used globally, including by a handful of Asian economies during the financial crisis in the late 90s to stabilise their domestic banking sectors,” Rao said.

Rating firm Crisil said around half of additional capital requirement for public sector banks is because of the step-up in provisioning towards corporate NPA accounts in line with potential haircuts on resolution. PSU banks needed Rs 1.4- 1.7 lakh crore in the event of accelerated provisioning as part of the NPA resolution process, it said.