IFC Rupee Bond success

IFC issued INR 1000 Cr of bonds to global investors which has been lapped up happily by foreign investors. For starters, it is a 3 year bond which got issued at coupon of 7.75%. The money collected by IFC will be invested into Indian companies and the investors take the currency risk. It leads to the question what are the foreign investors trying to tell us with the cut-off for the bond issue.

This leads to a direct question of why the coupon has been fixed at 7.75% not close to 9.25% where current 3Y corporate issues (AAA) should be trading at - as the currency risk is with the investors. 

As per my understanding, the intermediation of IFC is taking care of two main risks for which the investors are sacrificing close to 150 bps of yield pick-up despite taking on currency risk on INR:
1. Credit Risk: Even if the Indian corporates to whom IFC lends money defaults, the investors will still get back the money in INR terms. It is to be noted that IFC is AAA rated in $ terms.
2. Convertibility risk: Investors are assured of dollars at the end of 3 years; they are exposed to capital gain / loss depending on INR spot levels but they need the assurance of getting the dollars at the end of three years. Without IFC mediation, they could end up not being able to convert the INR into dollars - sounds like a risk India might totally stop outflows if things go further wrong from here.

Just for the record,US Treasuries for 3Y are at 0.60%; 5y BBB- (India rating) spread is close to 300 bps. Hence, India's dollar yield should be close to 3.60% for 3 years. For corporates, there would be a further spread of 60-70 bps taking the Corporate yield in dollar terms to 4.30%.  With INR yield of corporates trading at 9.30%, the IFC issue of 7.75% suggests foreign investors are pricing in the credit risk of AAA Indian corporates and Convertibility of INR to USD at 155 bps. 

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RBI: Money market rates and Rupee Defence

Having the benefit of a late response: RBI followed up the Jul 15 measure with further tightening this week: restricting the LAF borrowing by banks to 0.5% of the banks' individual NDTL - this does two things:

(1) Restrict overall LAF borrowing max at 35k Crs
(2) Making funding of excess SLR by banks and Primary dealers expensive and/or uncertain.

The excess SLR holding of banks is close to INR 4 lac Crores and that entire portfolio's funding cost can now swing between 7.25-10.25 which effectively means banks with excess SLR will not venture into adding to their portfolios at this point: good illustration is yesterday's and today's Tbill cutoffs of >11%, last week's devolvement og G-Sec auctionand likely devolvement this week as well. The yield curve could remain inverted till the measures are reversed and markets clearly perceive that inflation & currency risks are addressed and that the focus of RBI will shift towards growth. With the impact of the fresh reporting fortnight kicking in from next week, the movement in overnight rates could be interesting - one solace would the Govt's month end spending.

To see the impact of the RBI measures to FX market: the Forward premia and MIFOR levels have shot up in line with other rates curves effectively making it prohibitively expensive for anyone to buy forward dollars. This means different things for different players:
(1) If FII flows do come into debt, these would have to be unhedged by the sheer unattractiveness of the hedge - meaning RBI is directly signaling the long term players amidst FIIs like Pension funds, Sovereign wealth funds are welcome and not the arbitrageurs (aka hot money) playing the interest rate differentials.
(2) With an explicit support to INR spot, exporters still can forward sell their dollars at almost the same levels as in the 2nd/3rd weeks of July (despite the 90p downmove since Jul 15). This effectively encourages exporters to hedge and importers not to hedge.

From behavioural front, the sheer pain of most banks in their bond books would make them speculate much less in FX. After all, quarterly results and NIMs matter. 

Going forward, I would be keenly tracking how much redemption pressures come to Debt mutual funds. If that turns out to be material, along with the relentless supply till end August and queasy funding costs, yields can head higher even from these levels - we are already in uncharted zone in this currency cycle. On my personal HTM portfolio, I would put more money in debt funds than in equity funds at this point.

At the risk of being an hyperbole, money markets have got a step-motherly treatment to bring some stability to the favoured FX spot. All said and done, INR Spot will remain the cynosure of the central bank in the near term