Govt may buy debt at a discount

The Centre is likely to buy back the Rs 40,000 crore (Rs 400 billion) high-cost illiquid government debt from banks at a discount to the market price.

Finance Minister Jaswant Singh had in Budget 2003 announced a buyback of thinly traded domestic debt of the government.

It had specifically mentioned that while such loans should normally command a premium on their face value, banks were unable to encash them due to their limited liquidity.

According to officials, the banks may be issued fresh floating rate securities or a mix of floating and fixed rate securities in lieu of the earlier loans contracted by the government at high costs. The Centre has, however, not put any cost to the illiquidity of the securities.

Officials said the ratio of splitting the market premium on its past high-cost debt between the Centre and the banks would be decided in due course.

They also added that the illiquidity premium could not be high since it was necessary to ensure that all the banks holding a particular thinly traded security sold it under the buy-back scheme.

The finance ministry has already indicated that banks selling high-cost debt would be allowed to utilise the gains by making provisions towards their non-performing assets.

It has also said banks declaring the premium received as business income would be allowed additional deduction to the extent it is used for provisioning of non-performing assets.

According to a leading primary dealer, just about 25 per cent of the 140-odd government securities in the market are regularly traded.

"The Centre will be well within its rights to charge an illiquidity premium since there are several high-coupon securities which are not traded for months and years together," he said.

The primary dealer said it made eminent sense for the banks to shed their illiquid portfolios.

"If the interest rates harden in due course, the high-coupon illiquid securities are unlikely to fetch the banks the same premium as is available now," he added.

As on March 31, 2002, almost 75 per cent of the total Rs 5,36,108 crore (Rs 5361.08 billion) outstanding loans of the government carried an interest rate of 11 per cent or more.

Almost Rs 40,000 crore (Rs 400 billion) loans carry an interest rate of over 13 per cent. In contrast, the Centre is able to borrow from the market today at half the cost.

What's in it for banks?