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Cash premium offer in gilt buyback scheme

Mumbai, May 2: The Centre will buy back 24 outstanding illiquid government securities worth Rs 82,523 crore from banks in the initial phase as part of its debt buyback scheme announced in this year’s budget.

Finance minister Jaswant Singh had said in his budget speech that a large chunk of banks’ kitty of high-yielding, but sparsely traded, Central government domestic debt would be bought back from banks. This will help banks that are in need of liquidity or keen to encash the premium offered on these bonds to hedge better against non-performing assets.

Singh said the premium received could be declared as business income for income-tax purposes and the portion of it used for provisioning against impaired loans could qualify as deductions from the income of banks.

Finance secretary S. Narayan mapped out the contours of the plan today in a meeting with chief executives of commercial banks. Under it, the Centre will pay the premium in cash; it will issue new fixed-rate bonds maturing in 5 to 20 years for the remaining amount.

Here’s how it would work: If a security issued at Rs 100 now trades at Rs 115, the government will buy it a price below this. If a deal is done at Rs 110, a security worth Rs 100 will be issued, while Rs 10 would be paid in cash.

A tentative list of 24 securities that are to redeemed between May 24, 2004 and December 20, 2020 has been sent to banks, which have been asked to suggest additions.

Narayan said the Reserve Bank will prepare a software for screen-based price auction, and first such transaction, could be done by the end of this quarter.

The finance secretary said the transactions would be structured as a “switch” operation under which fresh securities will be issued in lieu of instruments being bought back. Both will take place at the same time.

The deal will be structured in a way that its impact on the fiscal deficit — due to the premium paid by the government — does not exceed an amount to be fixed prior to the auction. The sum paid as premium will be pre-determined, and will not exceed the auction amount.

At the auction, bids indicating the prices of security and amount will have to be submitted. The discount implicit in each bid will be worked out using the market price data of the preceding the auction. The bids will be arranged in decreasing order of discounts. Banks quoting higher discounts will be preferred.

After this, the amount of premium payable by the government for each bid will be calculated. The cut-off will be the point where the premium matches the fixed amount.

Narayan said he has made a suggestion to make the buyback auction screen based, so that price discovery is anonymous. Bids could come from across the country and the provisional cut-off price for each security would be displayed on screen in real time. Bids can be revised and auction will be only open for a limited time.

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