As the Reserve Bank of India tries to support weakening rupee, India’s foreign exchange reserves are declining steadily. From $314 billion in April, they have fallen to $245 billion as on November 21, a fall of nearly 22 per cent in under nine months.
Even as foreign institutional investors are busy selling their investment, exports have started doing badly. With global recession spreading, demand for India’s exports have declined, particularly in the US and Europe.
For the first time in several years, they have actually declined in October by 12.1 per cent to $12.82 billion from a year ago. Besides, corporate India is finding it difficult to raise foreign exchange loans abroad at reasonable rates.
It may be too early to talk of a foreign exchange crisis, but it may be prudent for authorities to think of their options in case of such an eventuality. One option to raise supply of foreign exchange in the Indian market is for the government to issue sovereign bonds.
Every time this topic comes up for discussion, passionate arguments can be heard on both sides — those in favour of this option, and those against. Experts who argue for exercise of such an option are of the view that market appetite for such bonds is good, given the huge amount of spare cash lying idle with global banks.
The credibility of Indian government is excellent, and currently not too many good quality papers are available in market. But those who oppose the idea of Indian government issuing sovereign bonds point out that India’s fiscal deficit is too high to generate investor confidence.
Even otherwise, it is a risky idea, given the “fair weather friend” nature of global investors. There is also no need for such a move, because, according to these experts, the flow of non-resident dollars is good and will continue.
Which side will government tilt is a matter of conjecture at this stage, and will be governed by circumstances prevailing in next six months or so.
Meanwhile, a recent working paper on the International Monetary Fund site throws light on advantages and disadvantages of floating sovereign bonds, and outlines main preconditions that countries need to consider before contemplating bond issuance in international markets for the first time.
The paper (Strategic Considerations for First-Time Sovereign Bond Issuers by Udaibir S Das, Michael G Papaioannou, and Magdalena Polan; IMF WP/08/261) points out that a growing number of countries have, over the last decade, entered international capital markets for the first time with bond issuances.
Factors that enabled these countries were improved domestic macroeconomic conditions, enhancements in debt management frameworks, ample international financial liquidity, and strong investor appetite for new asset classes and higher-risk instruments.
While issuing sovereign bonds would help a country augment its savings, such a measure is also full of risks.
“The key challenge for all sovereign bond issuers, including first-time issuers, is to maintain sound macroeconomic policies, especially fiscal sustainability. This is needed to ensure sovereign creditworthiness, as international investors’ confidence...is often fragile and quickly reversible,” the authors have said.
Other risks include foreign currency exposure that such an issue creates, possible refinancing needs — especially in periods of tight international liquidity conditions — and adverse terms-of-trade shocks.
The paper has brought out leading characteristics of first-time sovereign bond issues in last few years. It found that a majority of emerging market sovereigns issued at least $500 million, the minimum size for a bond to be included in a bond index.
In addition, almost all recent first time sovereign issuers had fixed coupon, bullet bonds, with maturities of five or 10 years. Most of the initial bond issues were denominated in dollars and offered relatively high coupons to attract greater investor interest.
Further, most recent initial issues were privately placed or issued as eurobonds rather than as global bonds.
The authors also point out that a key factor in success of such an issue would be its size. It could not be very large, lest it endangers the country’s debt sustainability. Also, it has to be ensured that the issue’s debt servicing does not create budgetary imbalances.
“The size of the first time issue is a critical consideration. In determining the appropriate size, principal consideration must be given to how much funds will need to be raised from markets in, say, the next few years, with the main question being whether to divide this total into more than one bond issue.
“When proceeds are to be used only slowly, the total desired funding can be obtained either by new issues or by re-opening the first issue in order to minimise the negative carrying costs,” the authors point out.
At the same time, the issue should be large enough to create market liquidity.
The paper also points out three mistakes committed by recent first time issues: The size of the issue in some cases was too large; bullet bonds were issued, which magnified repayment and rollover risks; and better preparation could have achieved better pricing.
As a first time issuer, India, if it decides to issue such bonds, will have to be careful to avoid these mistakes.
