Bloomberg News

Rupee Default Swaps Flop as Global Funds Kept Out: India Credit

December 14, 2011

Dec. 8 (Bloomberg) -- India reported the first transaction in credit-default swaps one week after the central bank introduced the contracts, suggesting policy makers may have to open the market to global investors to boost trading.

Clearing Corp. of India, a Mumbai-based bond-settlement agency, reported trading in two of the contracts used to insure against debt default yesterday after local lenders and units of foreign banks were allowed to buy and sell rupee-denominated swaps starting on Nov. 30. Participation of international investors will deepen the market, according to Bank of America Corp. and Fidelity Worldwide Investment.

India became the second nation after China to have local- currency swaps when the Reserve Bank of India allowed trading in the contracts eight years after first mooting the plan. Investors won’t be able to buy the credit protection unless they own the underlying bonds. The cost of swaps to protect the debt of State Bank of India, considered a proxy for the sovereign, increased 88 basis points last month in London, while Bank of China Ltd.’s rose 40.

“Investors will need more experience in rupee default swaps to deal actively,” said Krishnamurthy Harihar, a Mumbai- based treasurer at the Indian unit of FirstRand Ltd., Africa’s second-largest bank. “Participation of foreigners will stoke interest in the CDS market.”

ICICI Bank Ltd., India’s second-biggest lender, bought credit protection on Rural Electrification Corp.’s one-year rupee debt from IDBI Bank Ltd., N.S. Venkatesh, Mumbai-based IDBI’s head of treasury, said yesterday. A contract on Indian Railway Finance Corp.’s securities was reported to Clearing Corp. yesterday.

Plans Delayed

Policy makers postponed introducing the default swaps in 2003, citing a need for banks to improve their risk-management practices. They held off again in 2008 as global credit markets seized up.

Investors in China have been buying and selling default swaps since November last year, making it the only other Asian nation to have local-currency swaps. France’s BNP Paribas SA and U.K.-based Barclays Plc’s China units are among 42 banks allowed to trade the swaps as of Oct. 14, according to the website of the National Association of Financial Market Institutional Investors. The association doesn’t publish trading volume for the contracts on its website.

Holders of default swaps must dispose them of within 10 days should they sell the notes that are being insured, according to the central bank.

‘Slow Market Growth’

“The industry agrees that these sorts of restrictions will slow market growth,” Keith Noyes, the Hong Kong-based regional director at the International Swaps & Derivatives Association, said by e-mail on Dec 5.

The Reserve Bank, which had proposed permitting companies, primary dealers, insurers, provident funds and even overseas funds to deal in default swaps in a May 23 discussion paper, diluted the final rules to allow only local banks access to the contracts, probably because of the European debt crisis, according to SJS Markets Ltd.

“It’s the first step and is better than nothing,” Atul Gharde, a Hong Kong-based credit analyst at SJS Markets, said in an interview on Dec. 5. “It will probably open up as the regulators get more comfortable.”

Default swaps on State Bank debt have doubled this year on concern seven interest-rate increases will slow growth and raise non-performing assets. The cost of protection on the lender was 348 basis points yesterday, compared with 160 basis points at the end of last year, according to London prices from data provider CMA, which is owned by Chicago-based CME Group Inc.

Rising Yields

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point, or 0.01 percentage point, equals $1,000 a year on a contract protecting $10 million of debt for five years.

Yields on India’s 10-year government bonds have increased 69 basis points this year as the central bank’s repurchase rate rose 225 basis points. The yield on the 8.79 percent notes due in November 2021 fell seven basis points to 8.53 percent in Mumbai, according to the central bank’s trading system.

India’s bonds returned 4.5 percent this year, the second- worst performance among 10 local-currency Asian debt markets monitored by HSBC Holdings Plc. The difference in yields between the nation’s sovereign debt due in a decade and similar-maturity U.S. Treasuries was 657 basis points, after widening 194 basis points this year.

European Crisis

Investors are also seeking higher premiums to hold India’s corporate debt as Europe’s sovereign-debt crisis saps demand for emerging-market assets. The difference in yields between three- year corporate bonds rated AAA by Crisil Ltd., a unit of Standard & Poor’s, and similar-maturity government notes was 186 basis points yesterday, compared with 150 at the end of last year, according to data compiled by Bloomberg.

Global funds agreed to pay 1.17 rupees for the right to buy every 100 rupees worth of government bonds at an auction held by the Securities & Exchange Board of India on Nov. 30, according to three people familiar with the matter. They agreed to pay 0.67 rupee for permits allowing purchases of every 100 rupees of corporate notes.

Investment Cap

International investors’ combined ownership of government and corporate debt increased 30 percent this year to a record $23.1 billion as of Dec. 5, according to exchange data. The government has set a $60 billion cap on their investments. Within that limit, global funds are allowed to buy $45 billion in corporate securities, including $25 billion in infrastructure financing.

“I don’t think that the constraints to CDS trading will be a limit to foreign investment in infrastructure bonds,” Rajeev De Mello, the Singapore-based head of Asian fixed income at Schroder Investment Management Ltd. who oversees $6.5 billion, said in an interview on Dec. 5. “More CDS will make the corporate bond market more liquid over the long term.”

The sliding currency, together with the absence of credit protection, makes India’s corporate bonds less attractive to global investors, according to Fidelity. The rupee weakened 0.3 percent to 51.8550 per dollar, taking its slump for the year to 13.7 percent.

‘Doesn’t Help’

The exposure to India’s interest rates “is more compelling than the currency,” Bryan Collins, a fixed-income portfolio manager in Hong Kong at Fidelity that manages $207.9 billion globally, said in an interview on Dec. 5. Keeping global funds out of the credit-default swaps market “doesn’t help the situation,” he said.

India was the only country of the biggest emerging nations to raise borrowing costs this quarter, boosting the repurchase rate to 8.5 percent, compared with the U.S. benchmark of zero to 0.25 percent and the euro region’s 1.25 percent.

Global investors will be allowed into India’s swaps market “gradually,” according to Bank of America.

“They wanted to keep the rules restrictive in phase one,” Jayesh Mehta, the Mumbai-based managing director of the Indian unit of Bank of America, said in an interview on Dec. 5. “They have a road-map ready to open the market.”

--With assistance from Henry Sanderson in Beijing and Shelley Smith in Hong Kong. Editors: Ven Ram, Sam Nagarajan

To contact the reporters on this story: Anurag Joshi in Mumbai at ajoshi53@bloomberg.net; Lilian Karunungan in Singapore at lkarunungan@bloomberg.net

To contact the editors responsible for this story: Shelley Smith at ssmith118@bloomberg.net; Sandy Hendry at shendry@bloomberg.net


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