NEW DELHI WEEKLY ECON OFFICE HIGHLIGHTS

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SUBJECT: NEW DELHI WEEKLY ECON OFFICE HIGHLIGHTS



1. (U) Below is a compilation of Economic highlights from Embassy
New Delhi for the week of May 21-25, 2007.

REF: NEW DELHI 02347

CREDIT DEFAULT SWAPS TO
DEEPEN DEBT MARKET
--------------


2. (U) On May 16, the Reserve Bank of India (RBI) issued draft
guidelines for the introduction of the much-awaited credit default
swaps (CDS) that it has been planning since 2003. The availability
of CDS would enable banks to manage their credit risks better, A CDS
is a simple form of credit derivative that allows banks to insure or
hedge the underlying debt asset by buying protection and
transferring the risk of credit default to the investor (the seller
of the protection). RBI has decided to initially allow only simple
CDS's restricted to single-entity credit transactions for
rupee-denominated loans in the domestic market. The introduction of
CDS is a follow up to RBI's April 24 credit policy that promised a
"gradual process of financial sector liberalization" in India.
According to RBI's website, RBI considers it appropriate now to
introduce more financial derivative products because the risk
management architecture of Indian banks has strengthened and banks
are becoming Basel II compliant. Also, a recent amendment to the
RBI Act, 1934 provides legality to over-the-counter derivative
instruments, including credit derivatives.


3. (U) C.E.S. Azariah, CEO of Fixed Income Money Markets and
Derivatives Association (FIMMDA) explained to Congen that existing
RBI-defined single-entity credit exposure limits to business groups,
constrain banks from growing their credit exposures to the corporate
sector. CDS, Azariah explained, allows banks to reduce their
existing exposures to a single-entity by buying credit protection
for part of the underlying loan, freeing the bank to then lend more
to the same business group. He said that as the CDS market matured
and developed ratings, banks would be able to take increased
exposure to less-than triple A rated corporations. Banks and
financial sources in Mumbai have welcomed RBI's belated step to
introduce credit derivatives. They see this as the first step
towards triggering trading in corporate bonds. Also, they expect
this to be a forerunner to developing India's debt market as a
source for infrastructure financing. These assets are considered
long and risky exposures for banks that would need protection
against credit default.


4. (U) V. Srinivasan, Treasury Head of J.P. Morgan, said that the
RBI-proposed CDS is a small though positive step towards
liberalization. American financial companies such as J.P. Morgan
and Merrill Lynch are working with FIMMDA and Primary Dealers'
Association to persuade RBI to allow CDS's to be traded as is done
in overseas markets. Cash-deficit foreign banks would be more
interested in writing protection and trading in Indian corporate
debt, they noted. S.P. Prabhu of IDBI Capital said that a domestic
restriction when the corporate sector is growing rapidly is
resulting in exporting India's financial markets overseas, contrary
to the objective of making Mumbai an international finance center.
Our financial sources informed us that Hong Kong and Singapore have
emerged as the hub for credit derivatives, in the absence of Indian
market permission. According to Jayesh Mehta, Managing Director and
Head of Debt Markets, DSP Merrill Lynch, with Indian companies
borrowing overseas or issuing foreign currency convertible bonds
(FCCBs),credit derivatives of Indian corporations are being
transacted overseas. Comment: As discussed reftel, there is growing
interest in rupee-denominated products that RBI restrictions have
forced offshore. Allowing CDS's is an important step towards a more
liberal and deeper financial sector, and a step that directly
encourages much-needed long-term debt products to finance corporate
expansion and infrastructure. End comment.


5. (U) Visit New Delhi's Classified Website:
http://www.state.sgov/p/sa/newdelhi

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