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The market has for long been flagging India's currency risks. However, the government seems to be waking up to the crisis only after the central bank's liquidity tightening measures kicked in and the Street downgraded growth estimates for FY14. On Monday, the government indicated it was open to "all options" and hadn't ruled out a sovereign bond issuance yet.
Sovereign bonds are dollar-denominated bonds issued by governments for a period of five years or above with a coupon rate that is higher than benchmark rates. Sovereign bond issuances are common in emerging markets, which have high current account deficits. Earlier this year, Mexico issued a 10-year euro denominated bond at 2.81 per cent and Indonesia issued a dollar-denominated bond at 5.45 per cent. Indonesia's current account deficit in 2012 stood at 2.8 per cent of the GDP, while Mexico's was 0.8 per cent.
Global investors would compare India's fundamentals with that of other emerging economies before committing their dollars. Given all the macro-economic stress and slowing growth, foreign flows cannot be taken for granted this year. Deutsche Bank believes that financing the current account deficit will possibly be challenging in the prevailing market conditions.
There is no doubt that India needs to recoup its forex reserves through all means available, but sovereign bonds are typically issued when the economy is more on a strong wicket. The Indian government has issued dollar-denominated bonds thrice in the past to recoup falling dollar reserves and on all occasions, the situation has been better than now. The last one was the Millennium Deposit issuance of 2000-01.
A sovereign bond issuance by India at this time would come with its own consequences. For starters, the timing is not right. In 2000 when Millennium Deposits were raised, India had import cover of 10 months (against six months at present) and current account deficit was at 0.5 per cent of the GDP (against FY13's 4.8 per cent). A sovereign bond issuance would smell of desperation at this point, which is why the Reserve Bank of India is not in favour of it.
If at all such a bond is considered, the yields would have to be higher than the prevailing rates for foreign currency non-resident deposit rate of 4.5 per cent (for five years). If the government hedges this foreign currency risk, then the yields on these bonds would go up to 10 per cent. Also given India's precarious macro-economic situation, it's unlikely that investors will bet on the rupee's appreciation in future. Ravi Sundar Muthukrishnan of ICICI Securities believes that even though India's external liability situation is comfortable, a significant increase in external debt may call into question India's 'BBB-'rating.
