Economy: Sovereign Bonds, Borrowing, Policy, Rationale
Headline : The name is dollar bond Editorial 3nd Aug’19 IndianExpress
- During the recent Budget, the Indian finance minister announced plan of the government of India to borrow in foreign currency to finance the fiscal deficit.
- The plan is to raise up to 10-15% of government borrowing — $10 billion — from the first overseas sovereign bond.
The difference is that this is offshore borrowing from foreign parties:
- There are other ways the government borrows from foreign parties. For example, foreign portfolio investors are allowed, within some limits, to buy the government’s onshore rupee bonds.
- The difference now will be that the bonds will be offshore, denominated in hard currencies. Here, the government, rather than the investor (like in case of FPI involvement in India), will bear the exchange risk.
- The announcement has become quite contentious with many critics panning the decision as needless adventurism.
- The move has triggered two broad questions:
- Why this attempt at something totally new to India?
- Why now?
Rationale given by the government:
- Availability of cheaper credit:
- The budget proposal claims that the ratio of India’s external debt to GDP, at 5 per cent, is among the lowest in the world.
- But this, the government implies it can raise cheap money by tapping into the global savings glut at a time when interest rates are at historic lows.
- Making more Indian savings available for private players:
- The other rationale advanced by the government is that by moving a part of its borrowing offshore, it will leave space in the domestic capital market for corporates and thereby stimulate much needed private investment.
- This could have been a major motivation, as India’s total public sector borrowing today, on and off budget, not only takes up the entire financial savings of households but also eats into corporate savings.
Signalling the opening up of economy:
- From a purely objective point of view, a persuasive case can be made for the dollar bonds
- By far the biggest benefit will be the intangible impact of the government signalling its confidence about opening up the economy.
- We will attract not just larger foreign portfolio flows but, in time, also larger foreign direct investment.
Costs of borrowing:
- Critics have argued that the cost of borrowing in external markets will not be any cheaper than borrowing in rupees in the domestic market.
- It is true up to an extent. The lower coupon rate on bonds offered in foreign markets will be offset by the cost of hedging against the foreign exchange risk.
- But viewed from the larger perspective of the overall economy, there will in fact be cost savings. This is because the sovereign will command a lower interest rate than any other entity.
Reduced yields for private sector:
- The policy shift will also pave the way for Indian bonds entering global indices which will draw in index-tracking funds and reduce yields overall.
- Further, a dollar bond will enable India’s risk premium to be more accurately estimated, potentially leading to a rating upgrade.
Concerns over the move
Indian economy will be exposed to global economic sentinment:
- The biggest fear is that this sovereign foreign borrowing will make India exposed to the volatile global economic sentinment.
- Investors lend liberally when the going is good, but swiftly back out at the slightest hint of trouble, exposing the country to volatile exchange rates and market turmoil.
- For a country that had a devastating external payments crisis in 1991 and came close to another one during the taper tantrums of 2013, these are dire warnings.
- Critics have also contended that issuing debt in foreign currencies is a route followed by countries which are unable to issue debt in their own currency.
- India is certainly not in that category.
- If the idea is to attract more foreign inflows, it could be done by raising the ceiling for foreigners into onshore rupee bonds.
Could end up as a shift in location of borrowing foreign funds:
- Critics say the proposed dollar bonds may not raise overall foreign funding.
- Many investors who are now buying rupee bonds in the domestic market will happily pass on the currency risk to the government and switch to dollar bonds in the external market.
Government may end up overborrowing:
- There are concerns that cheap foreign money will be too attractive for governments and they may borrow too much.
- This could lead to balance of payment crisis, currency depreciation and greater difficulty in paying back the loan.
- Such moves have brought many emerging markets to grief, including Argentina and Turkey.
- There is no guarantee that India will not succumb to this temptation.
- Given India’s still fragile fiscal and financial sector situation, the costs of irresponsibility can be intolerably heavy.
- The government’s proposal is the right way forward but it’s an idea whose time has yet to come.
GS Paper III: Economy