Rupee Credit-Default Swaps Join Yuan to Become Asia's First: India Credit

India and China are poised to become the first emerging markets in Asia to trade credit-default swaps on local-currency debt as investors seek protection against losses from funding projects in the region’s fastest-growing economies.

Regulators in the two nations say they intend to limit the contracts to bondholders to deter speculators and avoid a repeat of the global financial crisis that was partly blamed on the $615 trillion over-the-counter derivatives market. That conflicts with the wishes of the industry’s trade group.

India needs money for a planned $1 trillion investment in roads, ports and power plants, while yuan bond sales climbed to a record this year. The cost of swaps protecting against a default by State Bank of India was 166.8 basis points yesterday, compared with 123.5 for Bank of China Ltd. and 43.9 for U.S. government debt, according to data provider CMA in New York.

“The ability to use credit-default swaps as a way to hedge India infrastructure risk is a positive development,” said Scott Bennett, the Singapore-based head of regional credit at the Asia unit of Aberdeen Asset Management Plc, which oversees $261 billion globally. Restrictions against speculation would help reduce volatility, he said in an interview this week.

The International Swaps and Derivatives Association, an industry trade group known as ISDA, said in a draft report to the Reserve Bank of India on Oct. 4 that there should be no restrictions because “speculators are necessary for markets to be more liquid, efficient and complete.”

Proposed Regulations

The Reserve Bank of India will prepare regulations after talks with investors and banks, according to a statement on its website dated Aug. 4.

“We are hopeful of starting it by the first week of January,” Shyamala Gopinath, the deputy governor of the central bank, said in the northern Indian city of Chandigarh yesterday. “We are working on the reporting platform. We are assessing various suggestions and feedback on the introduction of credit- default swaps.”

China will introduce credit-default swaps by the end of the year to help banks manage risk, though it won’t permit contracts on high-risk assets such as subprime mortgages, Shi Wenchao, secretary general of the National Association of Financial Market Institutional Investors, said in New York last month.

China Association

Credit-default swaps 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.

The People’s Bank of China formed the association in 2007 to help develop the country’s over-the-counter financial markets. No one was available for comment when Bloomberg News made a telephone call to its main office in Beijing yesterday.

India Prime Minister Manmohan Singh said March 23 that the country wants investors to provide half the $1 trillion needed for infrastructure spending in the five years starting April 2012. Road Transport and Highways Minister Kamal Nath said in an Oct. 5 interview with Bloomberg-UTV that pension funds in Canada and Europe pledged to invest in bonds issued by road projects.

Default swaps “will bring back those investors into the market who are comfortable with the market risk but not with credit risk,” Hitendra Dave, head of global markets for HSBC Holdings Plc in India, said in an interview on Oct. 11.

Draft Guidelines

The central bank said in draft guidelines issued on Aug. 4 that it will allow banks, financial firms, primary dealers, insurance companies and mutual funds to buy and sell credit protection. Home-loan firms, provident funds and listed corporations will only be able to buy protection.

ISDA says foreign institutional investors who hold rupee bonds should be able to sell protection as it would lead to a more actively traded market. It is “concerned whether there will be sufficient depth and liquidity given the proposed restrictions on the type of instrument and, more importantly, the permitted participants,” Jacqueline Low, ISDA’s Singapore- based senior counsel for Asia, said in an e-mail to Bloomberg News on Oct. 13.

India’s central bank postponed introducing default swaps in 2003, citing a need for banks to improve their risk-management practices, and held off again in 2008 as global credit markets seized up.

Busiest Year

The corporate bond market in India is poised for its busiest year since Bloomberg began tracking it in 1999. Sales have climbed to 1.52 trillion rupees ($34.5 billion), surpassing a previous record of 1.48 trillion rupees set last year. Chinese bond sales rose to 1.53 trillion yuan ($230 billion) from 1.47 trillion yuan in the same period of 2009.

The yield on India’s 7.8 percent note due May 2020 rose to 8.02 percent yesterday from 8.014 percent, according to central bank data. The extra yield investors demand to hold top-rated five-year company debt instead of similar-maturity government notes has shrunk to 65 basis points from 86 basis points this year, Bloomberg indexes show.

Securities & Exchange Board of India data show overseas investors more than doubled purchases of Indian debt this year to $10.5 billion as of Oct. 8 to benefit from growth in Asia’s third-biggest economy. Gross domestic product expanded 8.8 percent last quarter from a year earlier, the most since 2007 and the fastest pace among major economies after China’s 10.3 percent and Brazil’s 8.81 percent.

Likely Companies

The surge in inflows spurred Prime Minister Singh to increase the cap on international holdings of rupee bonds last month by 50 percent to $30 billion.

“Any state-run company, whether in the infrastructure or manufacturing space, will be a lovely candidate” for credit- default swaps, Krishnamurthy Harihar, Mumbai-based treasurer at the Indian unit of FirstRand Ltd., South Africa’s second-largest financial services company, said in an interview yesterday.

Power Finance Corp Ltd. and Rural Electrification Corp Ltd. would be suitable candidates to have contracts written on their debt, he said.

Power Finance, based in New Delhi, sold 9.5 billion rupees of 7.89 percent bonds last month that mature in 2012. Their yield fell to 7.866 percent yesterday, according to Barclays Plc prices on Bloomberg. The yield on Rural Electrification’s 18 billion rupees in 8.75 percent bonds due July 2025 was little changed at 8.735 percent.

The rupee advanced 4.6 percent since Aug. 4 to trade at 44.15 per dollar yesterday, according to data compiled by Bloomberg. The currency has strengthened 5.4 percent this year.

“India’s strong domestic savings pool should help meet infrastructure funding,” Sukumar Rajah, who manages $5 billion of Asian equities as chief investment officer at Franklin Templeton Investments, said in a telephone interview yesterday from Chennai. “This should throw up large opportunities for global investors.”