Economy: NRI Bonds; Resurgence at a price

Gains made by the BJP government in its maiden offer may mean little if the funds are not prudently deployed.

Finally, there is some reason for cheer on the economic front. After a long spell, cash-rich non-resident Indians (NRIs) are looking homeward. The maiden attempt by the Vajpayee Government to woo them, it appears, is making impressive gains.

The Resurgent India Bonds (RIBS) floated on August 5 by the State Bank of India, the country's largest bank, on initially hoped to mop up about $2 billion (Rs 8,700 crore) for the Government. But if the number of applications being received are any indication, the final inflow when the scheme closes on August 24 may well exceed $3.5 billion (Rs 15,200 crore). By the end of the day on August 19, over 61,000 applicants had written cheques for a sum exceeding $3.1 billion (Rs 13,500 crore ). "It's a very big success," crows SBI Chairman M.S. Verma. "It shows that NRIs are upbeat about the future and want to make India a strong and resilient nation."

More than that sense of patriotism, what seems to have lured the NRIs in droves is the high interest rate the five-year bonds offer. To make the instruments a prime draw, the bonds were denominated in US dollar, pound sterling and deutsche mark. The SBI offered an interest of 7.75 per cent in dollars in the US, when the average return that NRIs could get in local schemes was about 2 percentage points lower. In the UK, the bonds on offer had a yield of 8 per cent in pounds while the average local return possible was between 6.5-7 per cent. In Germany too, NRIs were promised a return of 6.25 per cent in DM when schemes there offered a mere 4-4.5 per cent. The high interest rate apart, the bonds have an exchange rate risk cover for its entire duration. This allays fears about the downward movement of the rupee and its impact on investor returns.

THE PROS

Politically safe to tap NRIs instead of multinationals. In sync with swadeshi.

Boost sentiments, negate sanctions and the impact of the country's downgrading.

Bolsters foreign exchange reserves in a short span and makes the rupee stronger.

More money will now be easily available for investment in infrastructure projects.

AND CONS

Relatively cheaper to woo multinationals, pension and insurance funds.

Expensive proposition with high interest rates and foreign exchange risk cover.

Quantum of new flows not certain. Strong possibility of transfers from existing schemes.

Strategy to invest unclear. Infrastructure projects yet to be identified. Delays will negate gains.

Such was the scheme's attraction that exporters at home too wanted to invest in it. North Block, however, did not agree. In foreign banks, investment managers worked round the clock to script special loan schemes for NRIs when the SBI announced the scheme. It was seen as a channel to make easy money. By parking their funds in the bonds through the NRIs, the foreign banks could earn up to 1.25 per cent more than what they could by investing in securities abroad. In the US, for instance, local securities would fetch the banks an interest of around 5.75 per cent. But by loaning money to NRIs for investment in the ribs, they could earn up to 7 per cent. From the NRIs' point of view too, it was a golden opportunity. Without ploughing in much of their own money, they could make an easy 0.75 per cent gain by simply borrowing from the foreign banks and investing in the ribs.

There was another incentive for the foreign banks. The SBI promised to park half the sums mobilised by the collecting bank -- in rupees -- at an interest rate of 9.5 per cent for a five-year period with the Indian base of the bank. It suited the bank here as the local cost of raising resources (from individual and corporate deposits) is much higher. Not surprising then that these foreign banks have accounted for over three quarters of the sum mobilised in the scheme.

The total inflow is expected to buoy sentiments on the foreign exchange reserves front. Besides the ribs, another scheme -- India Millennium Fund -- is to be launched shortly by the Unit Trust of India. Together, they are expected to rake in over $5 billion (Rs 21,750 crore) and thereby supplement reserves, necessary to keep the rupee in good health and avoid a Pakistan-like debt repayment crisis.

Right now, reserves at $24 billion (Rs 1,04,400 crore) are at a safe level. Even if all dollar inflows -- through foreign direct investment (FDI), foreign institutional investors, world bank loans and grants, exports and external commercial borrowings -- were to stop, reserves would still be adequate to meet the deficit on the trade account and debt servicing costs. For 1998-99, these forex needs will approximately amount to $15 billion (Rs 65,250 crore). The situation may not be alarming now. But country watchers are anxious about exports plummeting, net sell-outs by FIIs and other factors which can tell on reserves.

Plus, it is unlikely that loans from the World Bank will maintain their past pace of inflow. There is a lack of clarity on whether sanctions cover public sector undertakings or not. Such uncertainties have been primarily responsible for the downgrading of the country's rating by various agencies and the rupee getting knocked out against the dollar in recent times. An aggressive scheme like ribs then was perhaps a good way out. "Let's face it," says economist Surjit Bhalla. "We did conduct the nuclear tests, sanctions were imposed and sentiments were shaken. Under the circumstances, the high interest rates of the bonds are no big deal."

But there are some who differ. They believe the Government could have worked on cheaper options. Apart from the higher interest rate burden (rib rates are about 1.5 per cent more than existing NRI scheme rates), the exchange rate cover will also cost a packet. According to an estimate, if the rupee was to lose a mere 5 per cent of its value against the dollar every year over the next five years, every $1 billion (Rs 4,350 crore) inflow would cost the exchequer about Rs 400 crore. Getting FDI and long-term foreign funds, feel critics, would have been cheaper. "It looks to me like the Government was desperate to get the funds in," maintains Raghavendra Jha of the Mumbai-based Indira Gandhi Institute for Development Research.

Another question being raised is how much of the total inflow is new money. The argument is that a substantial part of the $3.5 billion expected to come in could be black money being converted to white or being transferred from existing NRI schemes. An upbeat Government, however, dismisses such contentions. "It's money in your foreign exchange kitty and it gives a great feeling of comfort," says Mohan Guruswamy, adviser to the finance minister. "It will help India tide over any uncertainty in the remaining part of the year."

Everything will now depend on how the funds are utilised. What the SBI will do with the money is not clear yet. Though there is mention of a substantial investment in infrastructure, the projects are yet to be identified. Unless the Government gets cracking on high-return yielding options, the celebration may be shortlived.