RBI unlikely to vote in favour of overseas sovereign bond in Aug 16 meet

The Reserve Bank of India (RBI) is unlikely to vote in favour of an overseas dollar sovereign bond in its meeting with the government on August 16. 

The RBI, according to sources, fear that signals by overseas bonds would end up disrupting local bonds, which is tightly in control of the RBI, with the central bank being the money manager of the government. However, the overseas bonds and local bonds cannot be on different pages for long and that would significantly erode the freedom of the RBI to manage interest rates in the economy. 

Even as RBI Governor Shaktikanta Das has refused to comment on the issue, insisting that whatever be the view of the RBI, it would be communicated to the government, sources said the RBI had already expressed its reservation on the issue and would formally do so during the August 16 meeting. 

Even as global yields are at near zero, or even below zero for many economies, and raising the fund would be cheap for the government, the central bank does not see a need for it, considering domestic bond yields have eased more than 100 basis points (bps) since January. 

The presence of a sovereign bond may work something like non-deliverable forwards (NDF) market in currency, which drives the sentiment in the domestic currency market. The RBI has no control over the NDF market, while it is largely driven by speculators. The exchange rate prevailing at the NDF market often determine the local rates. The connection gets more obvious during a crisis period. 

A recent RBI task force, chaired by former deputy governor Usha Thorat suggested ways to bring the offshore market onshore by providing the same kind of infrastructure and free trades onshore.

However, it is not easy to drive up a volume in bonds, unlike in currencies, and therefore such undue offshore influence is unlikely, but the RBI fears that signaling would be enough to disrupt the local markets. 

Another concern that all market participants fear is that whenever there is a sovereign bond in place, there are credit default swaps (CDS) written by underwriters who don’t hold the underlying, but are pure speculators. Worryingly, these CDS get traded and are further sliced and diced into different instruments. These then create a different class of assets that have no relation to the government, but sends signals to the domestic bond market. It is easy to manipulate the instruments, which can have a negative impact on the local bonds. 

“While this (CDS) will help in efficient price discovery, overseas issuances have been seen to have adverse impact on domestic market because in the overseas markets, many hedge funds and investment companies write CDS contracts without owning the underlying security and resort to pure speculation,” said India Ratings and Research in a note last week. 

The overseas sovereign bond issuance, therefore, will lead to “feedback process” getting further entrenched in the domestic debt market, “and this may weaken monetary policy transmission”. 

The RBI’s concerns are also something similar. 

Finance Minister Nirmala Sitharaman proposed issuance of such bonds in the Budget for 2019-20, arguing that India’s external debt was less than 5 per cent of the gross domestic product (GDP). 

At the end of March 2019, the total sovereign debt stood at $103.8 billion, which was 3.8 per cent of the GDP. 

Former RBI governors have objected to the move. Raghuram Rajan, for example, termed it a move that has no quantifiable benefit, but is full of risk. 

Even as the total issuance is expected to be about $10 billion, which is about 10 per cent of the gross borrowing, over time the issuance could swell, Rajan feared. He also argued that nations go to overseas when there is not enough resources to tap back home. That is not the case with India. Some Latin American countries fell into serious trouble after letting their sovereign borrowing rise to 30-40 per cent of the gross domestic product. 

A sovereign bond issuance may also take away the debt manager mandate from the RBI, which is something that the central bank does not want to give up for now.