Because the spreads on the Rs 17,680 crore they collected could be as high as 5.50 per cent-and sans exchange risks too.

By Gautam Chakravorthy

August 5, 1998, is a saffron-letter day that Yashwant Sinha, the country's finance minister, will never forget. Just over 7 months after he assumed office-much of which he had spent defending an error-ridden budget, backtracking on controversial proposals, and retreating into a sanctions-hit shell-he had, finally, something to bounce back with.

When the State Bank of India's (SBI; 1997-98 income: Rs 18,635 crore) imaginatively-named Resurgent India Bonds (RIBs) Scheme-a pet project of Sinha, he had personally announced it in Budget 98-opened, 83,000 Non-Resident Indians (NRIs) queued up outside the 125 branches of the 14 collecting banks (see table) to buy them in a patriotic endorsement of India's financial resurgence. The gross pickings: $4.16 billion.

Kudos. Or controversy? Hardly had the dollars settled when an uproar broke out in banking circles about the impact of the RIBs Scheme. BT analyses the real issues, and identifies the banks that will benefit from this fallout.

THE CONTROVERSIES. Perhaps the key criticism against the RIBs Scheme is that most NRIs merely withdrew their money from the other lower interest-bearing schemes the banks offer them-like the Foreign Currency Non-Resident (B) accounts-and bought these 7.75 per cent bonds instead. Admits M.S. Verma, 59, Chairman, SBI: ''Nearly 15-20 per cent (between $0.62 billion and $0.83 billion) of the amount collected may have come from existing FCNR deposits.'' Although there is no data to calculate it yet, several bankers BT spoke to estimate the cross-flows at $1.50 billion. Or over 40 per cent. Which casts a different light on the success of the scheme.

Another $1 billion may have come because of reverse hawala transactions and the liberal loans extended by foreign banks to NRIs to invest in these bonds. Of course, the Government Of India (GOI) refutes this theory, with Sinha arguing that since the scheme was open for only 19 days, hawala operators couldn't have arranged for so many investors to route the money through. However, a quick analysis shows that the average per capita investment was as much as $50,120-suggesting that either black money or institutional investments did flow into the scheme.

Finally, there could be a slowdown in the inflow of invisibles in 1998-99 because of the RIBs Scheme. Amounting to $9.80 billion in 1997-98, software exports and private transfers-or remittances by NRIs-are the 2 visible contributors to invisibles. If many NRIs did opt to invest their savings in RIBs, their other remittances may, logically, fall this year. Either way, there may not be much of a net gain to the exchequer because of the RIBs Scheme.

THE DEPLOYMENT. Inevitably, the paper success of the RIBs Scheme led to a struggle between all the banks in the country for a slice of the pie. Which intensified after the SBI was forced to convert, virtually, the entire proceeds into rupees rather than sticking to its original plan of keeping $1 billion outside the country. That's when even the banks not involved in the collection of the bonds staked their claims to cheap lines of credit. To placate such banks, like the TimesBank and the ICICI Bank, the SBI designated them as broker-banks, who would also be eligible for some of the funds raised.

Since the SBI must maintain the Statutory Liquidity Ratio and the Cash Reserve Ratio on the Rs 17,680 crore it collected, the net amount that became available to it was Rs 11,315.20 crore. In a deal, brokered by the Reserve Bank of India (RBI), the 14 banks which mobilised the deposits were collectively given 50 per cent-with individual ceilings-of the Rs 14,152.50 crore they collected. And the non-collecting banks were doled out the remaining 50 per cent, with similar caps on each bank.

As for the SBI-which was itself left with an investible corpus of Rs 4,238.95 crore-it will charge the other banks 9.50 per cent per annum on the funds. From its own corpus, the lead bank has already invested Rs 1,000 crore in a privately-placed bond issue (interest rate: 12.75 per cent) of the Industrial Development Bank of India (IDBI; 1997-98 income: Rs 7,037 crore), and committed another Rs 400 crore to two other private sector infrastructure projects.

Naturally, the other financial institutions, like the Industrial Credit & Investment Corporation of India (ICICI; 1997-98 income: Rs 5,969.86 crore) and the Infrastructure Development Finance Corporation (IDFC), are floating bonds to tap the surpluses with the SBI. While the former plans to raise Rs 1,000 crore, the IDFC is thinking of floating a Rs 500-crore bond issue. And the IDBI plans to raise another Rs 1,000 crore in the near future. Which fits in with the original rationale of raising this money.

However, the RBI has been worried that these inflows will result in an increase in liquidity until the funds are actually disbursed to infrastructure projects. So, the central bank has mobilised Rs 4,500 crore from the open market and, according to a senior RBI official, ''plans to offload a part of the monetised deficit at an attractive rate'' to mop up the excess liquidity. Else, there is bound to be a resurgence of double-digit inflation.

THE GAINERS. In a sense, the SBI may be the biggest winner of the RIBs Scheme. According to the investment bank, J.P. Morgan, the erstwhile Imperial Bank of India will earn an additional profit of Rs 600 crore in the next 5 years because of this scheme. Or an average of Rs 120 crore a year. Add that to the bank's net profits of Rs 348 crore in 1997-98-and the blue-chip looks red-hot.

According to BT's calculations, the SBI's cost of raising these funds-including commissions, administrative expenses, and only a part of the costs of exchange risks-can be pegged at 9 per cent. As against this, the bank will earn a 9.50 per cent interest from the money it has lent to the other banks, 11.75 per cent from its investment in government securities, 12.75 per cent from its subscription to the IDBI's infrastructure bonds, and 13.50 per cent from direct lending to infrastructure projects. Which works out to an average spread of 2.90 per cent on the total corpus.

Both the financial institutions-which are mopping up money from the SBI-and the banks-which received the money from the SBI-will also make a killing. However, there is bound to be a mismatch as the maturity period of the RIBs is 5 years while the money must be lent to infrastructure projects for 8-20 years. To wriggle out of this, the SBI recently entered into a takeout financing arrangement with the IDFC, which will allow it to take out its money at the end of 5 years even if the maturity of the loan is longer.

Of course, the NRI bond-holders aren't doing badly either, with the RIBs already attracting a premium of between 2.25 and 2.50 per cent. Agrees Mohammed Tariq, 34, Managing Director, Elfina Financial Consultants: ''We have already done such deals at a premium for $1-2 million, and have a demand for another $10 million.'' Apart from the high interest rates, buyers are attracted by the tax-breaks offered.

THE LOSERS. Conversely, there could well be a loss to the GOI because of the RIBs Scheme. Although the 7.75 per cent coupon rate on the bonds is pegged at 225 basis points (2.25 per cent) above the London Inter-Bank Offer Rate (LIBOR), the returns could be higher since it is the GOI that must bear the exchange risks. Explains Amit Agarwal, 28, an analyst with J.P. Morgan: ''Conservatively, my estimates suggest that if the Indian rupee depreciates by an average of 8 per cent per annum, the GOI will have to pay an additional Rs 875 crore per year on account of the exchange risks.'' Don't forget, the depreciation of the rupee between March and September, 1998, was 16.47 per cent.

To make sure that the loss is not reflected in the budget deficit-although it will in the fiscal deficit-the GOI has created a separate account, the RIB-Maintenance of Value Account, to cover the exchange risk. Under this, the RBI will lend money in the form of credit to the GOI. The GOI, in turn, will return the money in the form of non-negotiable, zero-interest securities to the RBI at the end of each year, ending September since the special account was set up last month. Since the SBI has to finance its commitment to bear the exchange risk to the tune of 1 per cent per annum, it will transfer the requisite amount from its P&L account into the specially-created account. Thus, the GOI will be able to phase out the negative impact on a yearly basis instead of facing the prospect of a huge outgo at the end of the 5-year period.

However, this cost should be weighed against the intangible benefits. Optimists like S.K. Shelgikar, 42, the Financial Advisor to the Rs 2,110-crore Videocon Group, feel that the money has been raised at low interest rates since the LIBOR+ spreads on Indian corporate paper had risen from 340-390 basis points in mid-May, 1998, to 500-600 basis points in August, 1998. ''We should now establish a favourable yield-curve for bonds of different maturities,'' he argues. That may not be possible since there are crucial differences between corporate debt offerings and government deposit collections.

Clearly, the RIBs Scheme is best seen as an expensive morale-booster for a government under siege. To the extent that it also raised resources for investments in badly-needed infrastructure projects, it cannot be faulted. Especially since the peacocks will come home to roost only 5 years from now. Until then, the banks will be laughing all the way to the bank.

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