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. 

Business Standard Link

INR – Target 60-61/$ - Next 3 Months

Factors behind the Current INR Downmove:

Outflows: The major weakness in INR began in the second half of May where significant outflows happened from Debt aggregating close to $9 Bn and Equity outflow of close to $1 Bn. 

CAD Concerns: Spike in Gold Imports on the back of Govt. action on increasing duties. Though expected to be front loading of the year’s gold demand, the resulting imbalance along with the Capital outflows exacerbated and quickened the down-move.

Debt Repayments: As a consequence of the negative sentiment on the currency along with QE Tapering Concerns, INR along with most EM peers faced severe depreciation pressures raising concerns about ability to raise fresh funds overseas and hence repaying capacity of existing debts.

External Debt Profile

• India’s external debt, as at end-March 2013, was placed at US$ 390.0 billion showing an increase of US$ 44.6 billion or 12.9 per cent over the level at end-March 2012.
• The share of short-term debt in total debt, by original maturity, was 24.8 per cent. Based on residual maturity, short-term debt accounted for 44.2 per cent of the total external debt as at end-March 2013. Of this, the share of NRI deposits was 28.4 per cent.
• The residual maturity profile and comparable countries’ debt profiles are as per the following tables:

Residual Maturity	< 1Y	1Y to2Y	2Y to 3Y	> 3Years	Total
Total External Debt ($Bn)	172	33	34	151	390
Corporate Debt ($Bn)	110	20	24	80	234
Sovereign Debt ($Bn)	13	6	6	60	85
NRI Deposits ($Bn)	49	7	4	11	71

CAD as % of GDP	2013	2012	2011
India	-5.10%	-4.65%	-2.99%
Brazil	-3.01%	-2.01%	-2.21%
Russia	2.98%	5.62%	4.21%
South Africa	-5.80%	-5.00%	-2.60%
Thailand	0.10%	0.66%	3.07%
Indonesia	-3.08%	-0.54%	0.82%
Malaysia	5.19%	10.44%	10.15%

Emerging Market Currency Performance:

The following table lists the relative performance of various EM currencies; INR’s performance is comparable to IDR and BRL though better than ZAR – mainly reflective of the higher CAD. With CAD% likely to go down this year to -3.7%:

Currency	1M%	3M%	6M%	YTD%
INR	-5.67%	-12.26%	-14.96%	-13.19%
BRL	-5.74%	-12.98%	-15.62%	-12.66%
RUB	-2.03%	-4.89%	-7.78%	-7.51%
ZAR	-5.48%	-6.98%	-13.47%	-17.28%
THB	-2.80%	-6.08%	-6.33%	-3.94%
IDR	-7.76%	-11.53%	-12.25%	-11.44%
MYR	-3.70%	-8.11%	-6.14%	-7.35%

Recent Movement in Foreign Currency Reserves

The Foreign currency reserves of the country have trended lower in the last 6 months – an indicator of the central bank intervention in the FX market.  With 44% of total external debt being short term, further erosion of FX reserves can be a major risk factor looking ahead. Hence, the capital raising efforts of the Government (the recent measures) would turn out to be “necessary” sooner than later.

Recent Measures announced to support INR

Following are the key measures announced by the Finance Minister in the last 2 weeks

• Easier overseas borrowing norms, especially for oil companies ($6 Bn): Two changes done in this regard – one, oil companies are allowed to raise $4 Bn to meet working capital requirements; two, subsidies of MNCs are allowed to raise debt from parent companies – expected to raise $2 Bn
• Liberalization of the non-resident India (NRI) deposit scheme ($1 Bn)
• Issuance of quasi-sovereign bonds ($4 Bn): Three public-sector financial institutions are expected to raise $4Bn by issuing quasi-sovereign bonds. Sovereign wealth funds can invest up to 30% in the INR 480bn of tax-free bonds to be issued by public-sector financial institutions. If fully utilised this could provide another $2 Bn of additional inflows in the remainder of FY14.
• Import duty hikes: Gold and Silver import duties have been hiked to 10% from 8% and 6% respectively; going by recent record, this is not likely to provide immediate impact.

Expected Outcome

Measures	FX	Rates	Credit Growth
RBI Intervention: continuation of periodic central bank action	Positive: Direct impact. Medium term impact is bad owing to erosion of reserves	Negative: as liquidity is expected to become tighter	Neutral
Continuation of Tight Liquidity Conditions	Neutral: Positive flows in debt likely to be offset by negative flows from equity	Negative: Direct impact.	Negative: NPA concerns to rise
External Fund Raising (incl quasi sovereign, NRI Depo & ECBs)	Positive: Ease funding concerns and positive capital flows	Positive: Can potentially lead to early relaxation of tight liquidity measures	Positive: Similar to Rates impact, headwinds are reduced

If the planned inflow of $11 Bn does happen, a 50% retracement of the last 6M move can be expected – with INR trading close to 60-61/$. Current 3M Outright Forward is ~ 65.50/$ : Target of 61/$ corresponds to a 7% absolute return objective.

Where to park your money

For anyone who is lucky/wise enough to be cash-rich and investment hungry at this point: I suggest the following:

1. Go Long India Debt Mutual Funds: Ideally, it is better to put the funds in a short term fund and start shifting towards longer term funds when RBI's money market tightening measures are rolled back.  For any reason, this can't be done (like tax considerations), it is advisable to go long in dynamic bond funds and not direct duration funds. Dynamic funds are better; it can be hoped they would alter the duration of the portfolio suitably while letting the investor park the money tax efficiently.

2. Go Long on US Funds: I can identify Franklin Templeton US Feeder Fund and ICICI Pru US Equity Fund  as potential opportunities. With the withdrawal of Quantitative easing on the anvil, it is likely that US economy will do well and US Dollar will do well. The latter especially will be hard on Emerging Markets like India and a choice of US equity denominated in US Dollars will act as a strong hedge against Indian equities which most of us would anyways have.

I am not suggesting totally ignore Indian equities; all I say is, incrementally increase the above two asset classes while choosing Indian companies who mainly export and are debt-free.