Why go for sovereign bonds?

Excess liquidity can turn into one of scarcity in the event of a financial crisis

Subir Roy
Senior economic analyst

Of all the fresh ideas in the 2019-20 Union Budget (it did not have too many), the one that has become the most controversial is the move to issue sovereign currency bonds in foreign markets to meet a part of the government’s gross borrowing programme.  

Virtually all commentators have opposed the idea, with some qualifying it by saying that a token issue will do no harm. The important thing will be not to go ahead with the practice in a bigger way over time. But going by news reports, the government seems to be not only moving ahead with the idea, but also looking at a fairly large issue of $3-4 billion to begin with.

The Indian Government has so far stayed away from commercial borrowing abroad, restricting itself to loans from multilateral agencies like the World Bank. This has allowed it to keep its sovereign external debt to a low 5 per cent of the GDP. Hence there is space now for some sovereign commercial debt to be raised abroad. But as Raghuram Rajan, former RBI Governor, has explained, this space would not have existed had the government done earlier what it is seeking to do now.

What is the government’s rationale for going in for a bit of what it has carefully stayed away from till now? Issuing a bit of, say, dollar bonds abroad at a very good — that is low — rate of interest will enable the government to create a benchmark which will then let private borrowers access funds abroad more cheaply than till now. The chances of the government getting a good rate now are high because the international markets are currently flush with funds.

But the present situation needs to be treated with caution. A scenario of excess liquidity can easily turn into one of scarcity if a financial crisis manifests itself. It is useful to recall that when the global markets were flush with petro dollars after the oil price rises of the seventies, Latin American countries were encouraged by global bankers to borrow freely and they did. Then, when the global financial crisis hit in 2008 and liquidity vanished, there was massive Latin American default.

Another reason cited by the government is that by taking a part of its borrowing programme abroad it will be creating space for domestic borrowers who will likely see a fall in interest rates. This will encourage greater private borrowing and facilitate the much-needed investment. But the government can achieve the same result, leave space for private borrowers, by directly taking recourse to the RBI and not have to go abroad.  

The foremost reason given by those who are opposed to the idea is that it will make the Government of India bear the currency risk. For repayment, rupees will have to be converted into dollars at the then going rate.

On the other hand, if the same foreign investors bought rupee-denominated government bonds in India at the time of encashment, they would be able to convert the rupees to dollars at the then going rate. If the rupee depreciates against the dollar over time, as is likely, the government would be the loser if it borrowed abroad and the gainer if it borrowed at home.

If despite this the government seeks to borrow abroad, it can be under one scenario. It needs to shore up its foreign currency reserves which are running low. This was the case when India faced its worst currency crisis in 1991 and went in for quasi sovereign borrowing by getting the State Bank of India to issue the India Development Bonds. The current situation, with reserves running at over $400 billion, is the opposite. India’s reserves are plentiful and there is absolutely no need to borrow abroad to acquire further reserves and take on a bit of exchange risk. What is more, further significant accretion to reserves will raise the value of the rupee vis-à-vis the dollar and make life difficult for exporters.

One question mark that hangs over the decision is its timing. The government has said it has been debating this idea internally over a long time and has now decided to go ahead with it. This prompts the question: Why right now?

By borrowing abroad the government will be integrating the economy further with the global economic structure. On the other hand, currently there is a degree of uncertainty across the world over the merits of globalisation which is a part of the free market system that has been embraced across countries since the demise of the Soviet Union. So, India seems to be moving towards globalisation at a time when there is a case for rethinking things.     

There can, however, be a non-economic reason for going in for this economic gambit. There is a good chance that at this juncture India will be able to issue foreign currency bonds at rates comparable to what the top economies are getting. Once this happens, India will have the pleasure of seeing itself among the leading global powers.

This will be grist to the mill for the current dispensation which likes to project a muscular image of India. It is the same mindset that has put the goal before the nation of becoming a $5 trillion economy. The bottomline is: We don’t need the hard currency, it comes with some risk but getting it under currently available terms will be good for our self-perception.

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