The benefits and drawbacks of tapping overseas markets for sovereign bonds

Critics fear India will pay the price Latin American nations did, in case of a global slowdown; supporters say the Centre is poised to further reduce cost of capital

The Narendra Modi government’s decision to tap the overseas debt market through sovereign bonds has stirred quite a debate. There has been a lot of criticism amid fears that India will pay the price that Latin American nations did, in case of any global slowdown and currency frustrations. Supporters, of the move, on the other hand, say that the Centre is poised to reduce the cost of capital even further and take advantage of the excess capital ‘sloshing’ around in the world’s capital markets.

Before we get into the advantages and drawbacks of overseas sovereign debt, here is what we know so far:

Finance Minister Nirmala Sitharaman, in her maiden budget speech on July 5, had announced: “India’s sovereign external debt to GDP is among the lowest globally, at less than 5 per cent. The Government would start raising a part of its gross borrowing programme in external markets in external currencies. This will also have a beneficial impact on the demand situation for government securities in domestic market.”

The bonds will be issued in the second half of fiscal 2019-20. Government officials have clarified that at the most, 10 per cent of the year’s total gross borrowing requirement will be raised overseas. That amounts to roughly $10 billion.

As reported in Business Standard, in a bid to set a benchmark and create a market, the first tranche of the sovereign bonds may be no less than $3-4 billion, and will likely be simultaneously launched in major financial centres like London, Singapore, Hong Kong, New York and others.

Also, the government favours a long-term tenure for the bonds, no less than 20 years, and top officials will embark on roadshows to drum up investments once the contours are finalised. The roadshows to major financial cities to meet big institutional investors could include Finance Minister Nirmala Sitharaman, Minister of State for Finance Anurag Thakur, Finance Secretary Subhash Garg, Reserve Bank of India Governor Shaktikanta Das, Chief Economic Advisor Krishnamurthy Subramanian and others.

The Finance Ministry, which will issue these bonds, unlike the domestic bonds issues by RBI, will start talking with investment banks in August to get a better understanding of the global bond markets. The contours of the instrument will be finalised by October, including the currency these bonds will be pegged at, whether dollar, euro, yuan or others.

Benefits:

Soumya Kanti Ghosh, Chief Economic Advisor at State Bank of India says that $10 billion in overseas sovereign debt would amount to merely 2.3 per cent of total India’s current forex reserves and 29 per cent of net foreign direct investment flows in 2018-19. This amount would also be a third of the minimum amount of sovereign debt issued in international markets.

“Going by international evidence, India is best placed to tap the sovereign bond market now. Comparison with Latin American and Asian economies is imprudent and naïve. The government is not planning to go overboard with its external borrowing programme,” Ghosh said.

He said that some economies had an average 51 per cent of debt denominated in foreign currencies to GDP, debt/GDP at 124 per cent, and current account deficit/GDP at 6 per cent. In contrast, India’s external debt/GDP is at 19.7 per cent, sovereign foreign currency debt /GDP at 3.8 per cent and investment inflows /GDP at 1.5 per cent.

“However, we still recommend that a strong balance of payment situation and a fairly stable exchange rate is a must for  long term foreign borrowing and a prudential limit must be set for such borrowings as a percentage of GDP. Additionally, RBI should bring down the forward premia cost to keep the interest of FPI in existing rupee bonds,” he said.

“We believe the direct benefit of a lower cost of borrowing may not be significant. This is because of the swap cost that is always associated with such borrowings.  However, the indirect benefit will be significant as with the bond yields softening it will help banks to increase their bottom-line through treasury profits. This will have positive impact on provisioning ratio of the banks,” he said.

In a post budget-interview with Business Standard, Garg had said that countries whose foreign bond issuances hadn’t gone well, was because of their bad economic management. “For example, Argentina. The biggest reason for their economic situation earlier was that they had pegged their currency with the dollar on a 1:1 basis. That was completely unsustainable. So whether you issue sovereign debt or not, if your economic management is bad, you will suffer,” he had said.

Drawbacks:

The most high-profile criticism has come from former RBI Governor Raghuram Rajan. In an article in The Times of India, Rajan had said the decision to issue foreign currency debt had no real benefit and carried a lot of risks.

“If the government wants to attract more foreign money to supplement domestic savings, it does not need to issue a sovereign bond, all it needs to do is to increase current ceilings on foreign portfolio investment into government rupee bonds. The effect is the same – more foreign inflows – but the government security is issued in rupees. So why issue a foreign currency denominated bond?” he had stated.

“Times when the rupee depreciates significantly (such as during the taper tantrum) are times when India’s image amongst international investors is bad, and the higher repayment requirement on dollar debt could lead to even greater market turmoil.  For this reason, most countries issue government debt in foreign currency only when they are unable to issue in their own currency,” he said.

In fact, the Swadeshi Jagran Manch, which is the economic wing of the ruling party’s ideological fountainhead Rashtriya Swayamsevak Sangh, has demanded that Modi government review the plan. Its co-convenor Ashwani Mahajan has called the move anti-patriotic as it could create long-term risks for the economy, potentially allowing rich foreign nations and their financial institutions to dictate the country’s policies.