HR Khan on why a robust bond market is a must for India

A group of regulators and government has been working on implementable recommendations to improve the debt market and a lot of action can be expected in market shortly, he said.He also shared his views on the steps that can be taken to boost the bond market, timetable for bond market reforms and FCNR outflow. Below is the verbatim transcript of HR Khan's interview to Latha Venkatesh on CNBC-TV18.Q: Let me start where the governor ended his previous monetary policy press interaction, he said that repo in corporate bonds will be allowed and Mr Khan is going to be in-charge of a committee that will present the roadmap to it. Can you tell us how soon we will be having repo in corporate bond markets?A: Let me give you a bit of a background about corporate debt market, which we have been talking since ages. There are structural issues and in fact not many countries also have very robust corporate debt market and many countries like India have a bank dominated system but corporate debt market is assuming criticality because there is a risk diversification, it compliments and supplements banks are doing and more particularly Indian context, it has also assumed importance because given the bank\\'s position in terms of their non-performing loans (NPLs) and other constraints, there is a need to develop corporate debt market and particularly when we are also planning to see that corporates at an aggregate level, they should not get overexposed to the banking sector part of their financial requirement should go to the market and through the bond market. So if that is the case then we need to do what all need to be done to develop corporate debt market.Q: It was in that context that I thought it was very crucial that RBI is contemplating allowing corporate debt in the repo transactions?A: The whole idea is that it would be a major change in terms of -- we are only taking sovereign papers so far as the repo is concerned. However, if you see world over, there are central banks whether it is unconventional monetary policy or quantitative easing and all, they have gone for corporate debt paper and expanding their balance sheet.In RBI, we have been conservative and rightly so because given the illiquidity of corporate bond market and credit risk that may come and probably it may have impact on the balance sheet but we have to move on in the sense that we want to develop the corporate market, we have to do something which will be a game changer.Q: Is that committee report, which you were leading, ready, submitted?A: FSDC has been discussing about this corporate debt market for quite some time. Then about few months ago, the sub-committee of the FSDC decided that let us have a group of all regulators and government to give a list of implementable recommendations, not go for a big report because there have been many reports on this corporate bond market to call out what all can be done and what new things we can do for the corporate debt market.So we had all the regulators and government we sat together and we have worked out -- the job is almost done and it is being submitted. Broadly, we had tried to look at what are the factors, which can further enable development of corporate debt market, which I put it in a characteristic manner in terms of issuer, in terms of investor, in terms of infrastructure, in terms of intermediaries, in terms of instruments and incentive and innovation.Q: Therefore from what you are saying, it looks like a repo of corporate bond in RBI’s liquidity adjustment facility (LAF) is only one part. You have many other recommendations?A: Yes, many other parts, and all the parts have to play together and in fact, most of the regulators and particularly RBI and SEBI are mostly involved and we have good understanding and quite a few things, implementers and timelines are also being suggested. So, we will see a lot of action in the next couple of months in terms of actual implemention.Q: So, which other areas? The LAF is one. What are the other things possible?A: If I can take you through very quickly for example, on the issuance side, we have not seen much reissuances. And volumes are not there so liquidity is not there. And on corporate side, there is a problem because bunching will be there. So, what we are trying to say that whether you can have same International Securities Identification Number (ISIN) number but different redemption date so you can do it so, National Securities Depository Ltd (NSDL) and the Central Depository Services India Ltd (CDSL) will probably work on that. And the other thing is that if you do reissuances, the stamp duty can be removed so that there is an incentive for reissuances.Similarly, in the case or for example, investor. We have not allowed foreign portfolio investors to invest. So, now as announced in the Budget, now unlisted bonds and PTC, they will be allowed to invest. And if you talk of intermediaries, the very critical point is market making. So, what we are looking at is whether some of the brokers can be market makers and if they become market makers, what sort of support they can get. So, they probably will get an access to repo and corporate bond market which is not allowed to them. So, if they get an access through repo to the market repo, probably they can make market. But then exchanges are working out a scheme and I think it is in advance stage of being implemented. And the other is in terms of banks, and primary dealers are already trading members. So, they could be also encouraged to become market makers. And if you see the infrastructure side, there are quite a few things. For example, one is electronic book for this private placement. And there is integrated trade repository where both primary and secondary market issuances one place, prices, volume, everything is available. And one critical element of infrastructure is credit rating agencies who play very important role. So, they will be encouraged to become members of credit information bureaus. So, they can access information. They are eligible users, but many of them are not members. And also possibly, going forward, whether they can be given access to Central Repository of Information on Large Credits (CRILC) data, but that has to be used very carefully, because SMA-2, SMA-2 does not mean that it is full default. So, probably that is one area. And other critical part is some of the instruments we have introduced, they have not really taken off.Take the example of credit default swap (CDS), repo in corporate bond. For example, in CDS we allowed few things, it does not work. In the corporate debt repo, we have reduced the haircut, allow CDC does not work. Q: So you will allow more partial re-enhancement?A: So, what we are trying to do is in terms of CDS, the main issue which has been a stumbling block as per the market is this netting issue involving public sector because of that capital charge increases. So, we were in dialogue with the government whether we have that amendment to the RBI act, netting and if that is not possible, pending that whether based on legal opinion we got second tracked whether the netting can be allowed. So, that will be a big boost. And so far as repo is concerned, we would like to have a screen based platform. Some cases where the liquidity can be a central counter-parties (CCP) facility and some where it is not liquid it can be without CCP facility. So, that is one area where we can work for this instrument.And other is of course, tripartite repo but better collateral management. The other issue is very important from the point of view, incentive. We came out with this partial credit enhancement. The while debate over the years has been that corporate debt market has to stand on its own without support from the banks. You remember the Tata sons case. But then we realised if you want corporates to move part of their requirements to bond market, at least in the initial stage or the nascent stage, some bank support will be needed. That is why this partial credit enhancement by way of a compromise sort of thing was brought, but that has taken off. So, one of the thinking of the group is that whether the 20 percent limit can be increased. But without making each individual bank over-exposed, whether that can be.Q: It is credit enhancement is capped at 20 percent.A: So, it can be increased, maybe 30-50 percent. And also, NBFCs were providing credit enhancement, for them there may not be any limit. Q: But what is the timetable for all this?A: Another very critical point in terms of incentive as I have stated is that corporates’ exposure to the banking system as a whole should come down and part of that, they should go to market. So, that is a work in process and RBI will come out with their own recommendation. And of course, finally, as you mentioned is this LAF eligibility. The whole idea is that once the market repo, tripartite repo gets some traction, there is some liquidity, probably we can open up this for LAF, but we have to see the legal aspect because RBI act is not very clear in terms of whether we can accept or not accept. That will be examined. My hunch is that pending RBI act amendment possibly we can do. And very important thing which has happened is this bankruptcy code which is one of the main stumbling blocks. We have now the bankruptcy code in place, but the challenge lies in creating the infrastructure of ports and insolvency professionals.Q: National Company Law Tribunal. That certainly is something which the whole nation is looking forward to. But I just wanted this. The most attractive proposal or rather one of the more attractive proposals is allowing corporate bonds to be used in the LAF window. The legal opinion at that time was that the RBI would only take sovereign paper. Is this settled?A: I would say it is not settled, but we will be in a position to interpret that it can be taken. Of course there has to be very sound risk management practices in terms of ratings, in terms of haircuts and all that. But if there are ambiguities, better to get the act amended. So that view has to be taken.Q: Now, I wanted to know the timetable. When can we expect some of these?A: Many of the things should happen over the next two months.Q: So in the current governor’s tenure itself some of it may be implemented?A: I suppose so. Some of the things will happen. For example, allowing FPIs to invest in unlisted debt and PTCs can happen anytime. And few things market making and all that SEBI is in advance stage of doing it. And we are also in dialogue with Pension Fund Regulatory and Development Authority (PFRDA) and insurance companies, they will also slightly relax their norms for investment. And for example, it even bonds of banks, so insurance companies and PF bonds, they will probably be investing. So, we are in dialogue with them. So, some of the major recommendations are likely to be implemented sooner than what was expected because the whole idea of this group is to give the recommendation and lay down some timeframe.Q: Is the RBI completely satisfied that the USD 26 billion odd money that will flow out when the Foreign Currency Non-Resident (FCNR) B deposits mature will not cause problems in the foreign exchange (forex) market?A: I would say we should be reasonably confident to handle this particular episode, but as you know there is always known unknowns and unknown knowns. But my hunch is that so far as the rupee liquidity is concerned, there should not be any problem, we will be able to handle. Forex liquidity is concerned, we have forex reserve, we can handle. The problem possibly arises that what they have lent to the exporters’ banks and the exporters do not repay, then problem. But there two safety walls. One is exporters will not keep on rolling over, because they have also borrowed. And second is if there is a stability in the currency market and people do not take a bet that rupee is going to depreciate sharply, there is no incentive for them to roll over. So, barring a few banks here and there, overall basis, one should not worry much.Q: We were given to understand by the market that RBI would speak on a case by case basis to each bank to check their positions. All that is done?A: I am not sure what has happened, but I believe that one to one talk has taken place and is taking place.Q: So, there should not be much of a ripple even in the government securities (G-sec) market because anyway those were not statutory liquidity ratio (SLR) bonds. They were not backed by SLR. That was not a problem. The other issue that has cropped up lately on the external investment issue. Is Docomo threatening that they will take Reserve Bank and Government of India to court because they were promised a certain return by the Tatas and the Tatas are ready to pay but the law does not allow or RBI and government, RBI was agreeable but the government has rejected that suggestion. How does this get solved? Is this the only case? Will there be more people who will take you to court?A: There are a few cases. Let me give you a bit of a background and history to it. What happened, when we had clamped borrowing from abroad, people, some of them brought debt in the garb of equity. And there was some element of assured returns. So, that is where we have to clamp it and clarify it. But, there is, things remain dynamic. They do not remain frozen in time. There are for example, private equity (PE) investors, there are other investors whose horizon is different and there are investors who will like to invest up to a point, beyond that they will exit. So, if you want to create an enabling environment, we thought that we should provide some exit clause, but without any assured return. That return could be linked to market determined rate. So, that is why we have been in dialogue with government. Capital account transaction, both RBI and government have to agree and we have an understanding of agreeing on the policy issues and capital account transactions. So, we have been in dialogue with the government that future cases, wherever there is, because for example, infrastructure, our startup areas where people will like to commit up to a point, beyond that, they will like to exit. So, what sort of framework we should provide. One way is that you give them a market determined rate, at this rate, you can exit. So, that is future. So far as the past cases are concerned, my understanding is that there should be at least two dozen cases of different variations of Tata Docomo, because both the parties are involved. The fellow who invested and the fellow who was investee, both were knowing that it was not permitted. Of course, thanks to some of the lawyers and accountants who have advised the manner, they thought that it is appropriate, that it can be done. Some have assured 16 percent return, 18 percent return and they have created structures in such a manner that there is some element of assured return. So, that we have to handle. So, if I have to handle, how do I handle this old cases. Suppose people go to arbitration, people go to courts. So different judgements will come and we have handle that issue. Now, I am out of RBI, but I believe both RBI and government are ceased of that. And I believe there should be some solution found to handle this thing because it is unnecessarily we see it is the investment climate. What has happened, happened. We have to move on and move on, let us provide a framework so that the past cases can also. But what is your sense? Are the government and RBI moving towards creating new rules? At least for the future cases, there is a broad understanding, but for the legacy cases, the matter is being discussed and RBI is in touch with the government on that.Q: After your leaving RBI on September, the governor as well leaves. What is your final thought in the last innings at RBI? Was that fulfilling? If you had to compare, if you had to give one comment on the Rajan era, what would that be?A: I was fortunate to have worked with him and in fact, in some other interviews also I have said, I have seen three governors with three Rs, Reddy, Rao and Rajan. And all the three have one great quality, they are great gentlemen. And all of them were focused on professionalism, high level of integrity and focus on data and analysis. Dr Rajan, very interesting person in the sense, he has been an academic and normally, one expects that academic will only be talking on higher plane and more of theory, less of practice. But he was a 24/7 hands on person. So he had that both macro and micro picture in his mind and not only monetary policy, whether it is bank regulation supervision or even payment system and a whole host of financial inclusion areas. So, he is a real full service central bank governor and a real hands on man and a high level of professionalism and a high level of integrity. And he is a great listener also. He had really two ears.