Regular divestment better option than bond issues to recapitalise banks: Y V Reddy

Mumbai: Divestment or purchases of shares within legally permissible limit is more desirable option than issuing bonds to recapitalise ailing public sector banks, according to former RBI governor Y V Reddy.

The government recently announced a Rs 2.11 crore recapitalisation package for public sector banks, which includes Rs 1.35 lakh crore worth issue of bonds, Rs 58000 crore through divestment and Rs 18,139 crore infusion from the budget.

Though the package hailed by many, the former RBI governor has his reservations. “ It may be desirable to keep the option of divestment of shares or purchase of shares on a continuing basis within the legally permissible limits, whenever the market conditions permit” said DR Reddy in a speech delivered in Ahmedabad recently. In other words, government should have the flexibility to withdraw from ownership if fiscal needs demand within the legal framework. “This would give the first signal for non ideological but purpose oriented and fiscally prudent approach to the extent of investments in public sector banks.” Reddy said

The bond centric package too has fiscal costs, according to Reddy. The option preferred now seems to be a significant reliance on issue of bonds to fund the injection of equity. “Bond financing should normally imply increase in fiscal deficit, but it can be interpreted to define in a manner that it does not” said Reddy in his speech.

“Whatever manner it is defined, it adds to the fiscal burden in terms of payment of interest in future. This burden could potentially be compensated by returns on equity injected”

Such a huge bond issue would also have monetary implication. “Its monetary implications would depend on the revival of activity consequent upon injection of equity and the design of bonds” he said. The design of bonds will have to consider its overlap with monetary management, maturity, interest rate (floating or fixed) lock-in, tradability, SLR status, eligibility of LAF, etc. “Broadly, more the conditions or restrictions, higher would be the interest cost but with less distortions in bond markets and less complications in monetary management”.

But the design of bonds should allow an integration of these bonds into the debt market in near future to avoid fragmentation of markets, according to Reddy.