The change in withholding tax to 5 percent from 20 percent is a big change not only for the borrowers, but also for the Indian bond market per se, says Jayesh Mehta, managing director & country treasurer, Bank of America. Talking to CNBC-TV18, he says this can really change the entire game in the bond market in India. The permission at the moment stands at USD 75 billion, of which USD 37-38 billion has come in, and he sees the balance USD 37 billion coming in the by the year end.
Here is the edited transcript of his interview with CNBC-TV18
Q: How significant is this change in withholding tax to 5 percent from 20 percent, and what kind of an impact will it have?
A: This is very significant change. It came together with the tax residency certificate (TRC) and somehow TRC took the limelight. But if we really look at it, the cut of withholding tax to 5 percent is a big change not only for the borrowers, but also for the Indian bond market per se. This can really change the entire game in the bond market in India.
Q: Have you done any of the numbers? The permission at the moment stands at USD 75 billion if I am not mistaken. How much has come and how much can come in FY14 you think?
A: I am slightly more bullish than the rest of the people. I think that USD 37-38 billion has come in of the USD 75 billion. We have to give time to funds to raise their funds and get their internal process and all those things done. It may take 3-4 months, maybe five months for them to come. But by the year end, I see at least the balance USD 37 billion coming in. So, I am taking about significant change.
Q: One of the views in the market was that money which comes into debt comes on a fully-hedged basis. So, as soon as Foreign Institutional Investors (FIIs) bring in the dollars they will do a buy sell or a sell buy and immediately hedge it, unlike equities where they just bring the dollars and because it is kind of long-term money, which looks at other kind of yield and it is not usually fully hedged. So, therefore, what is the view on the rupee? Does it gain a lot because of this impending USD 30 billion?
A: When the real money comes in some of them may not really go for hedge. Secondly, some of them actually would hedge it out in the Non-Deliverable Forward (NDF) market and not really in India, because all said and done, though there is lot of flexibility with custodians, you can’t really cancel and rebook and other stuff, so that doesn’t matter.
At the end of the day, USD 37 billion which was not expected to come it is coming into the market – that really changes the scenario. So, our view on currency, from 57.50, we have actually changed it to maybe 53-55 range for the time being.
Q: What impact will this have on bond yields?
A: There are actually two technical factors, which need to get clarified – one is the interest payable between June 1, 2013 and May 31, 2015, so it is only for two years. We hear that it is due to some technical things, but if some sort of clarification comes on, it is good. Even if does not comes even that is good. But at least that will make the yield curve steeper. So you will have two-three years bond actually having much lower yield, which we had almost like a flat yield curve.
It has only changed recently in the last 15 days. We may actually see the yield curve actually getting little steeper between 3-10 years. It says the rates should not be higher than rate notified by the Government of India and people are trying to figure it out what exactly it means, but when these clarifications come that definitely changes the whole bond market scenario.
Q: Actually, I was coming to that part of the confusion. It looks at the moment that even historically-issued bonds will not pay a withholding tax of 20 percent, but will pay 5 percent for the next two years. So, there clearly the guys who are holding get a bonanza, the issuer has lost. But for those who are going to issue now how will you price it? You will have to price it at 5 percent interest for two years. So if you are selling a 10-year bond, it will be one price for two years and another price for remaining eight?
A: Let us not forget that we still have a very active local market. So even after the news we saw the steepness of around 5 percent. So, I don’t think from a issuer perspective the withholding did matter in terms of pricing, but it didn’t really matter because they didn’t distinguish between local buyers and the foreign buyers and in the initial phase because I still see the real big money coming only after 3-4 months.
All said and done, big funds will need to raise India credit fund and stuff like that. So that will take at least take 3-4 months to come in. In the meantime, you will have the local guys trying to buy that bond for 2-3 years maturity. So overall, you will have different set of new buyers coming in, so that’s the whole big change I am looking at.
Q: Do you think a cutting of withholding tax is sufficient to see FII investing even in the infrastructure bonds or do you think they will continue to have their preference towards the AAA rated bonds?
A: When we talk about infrastructure bonds, the Securities and Exchange Board of India (Sebi) and government have anyway merged the limit between corporate bond and infrastructure. If you look at infrastructure bond also, majority of them - if you remove the Non Banking Financial Companies (NBFC), the Indian debt market corporate bond actually consists of infra bonds itself.
So you name any public sector undertakings (PSU) bonds they actually qualify for infra. So yes, initially there will be preference for AAA and it is just like a market evolution. It is like when equities started off, naturally the FIIs came in first, then the Sensex, followed by the mid caps and others. So, this is a great start. This is great thing which has happened.
Q: Do you think FII money, even rupee bonds will come into anything less than AAA?
A: Yes, it will take time, but it will definitely come in. Why not? Why AA, A+ NBFCs, when they can buy equities of mid caps, why not debt?
Q: How much money do you see coming since ultimately in the first go? FIIs are going to prefer only AAA paper and the entire government bond amount has already been more or less used up for the corporate sector itself, although there is some what 50 billion or 45 billion available. How much will really come?
A: On the government side, 8 billion is still the gap – that will definitely come in. On the corporate side there is a gap of around 29-30 billion and definitely that will come in because even if you look at it, the issuance is there. That is one is the issuance, there is also a secondary market in India.
So there is secondary market plus issuance plus we are forgetting we have NBFC as a category, which is a large issuer of bonds and they are going to benefit a lot out of this. Many of them are AAA rated.