It’s hard not to notice the buzz that is around ever since Finance Minister, Nirmala Sitharaman, announced that the Indian government would borrow some of its funds in the overseas markets in foreign currencies. A fiercely debated issue, it gained even more traction when news reports all over suggested that Finance Secretary Subhash Chandra Garg was transferred to the Power Ministry all because the government was quite unhappy with the way he was handling the issue around the proposed sovereign bonds. For those of you who don’t really know what this huge fuss is about, worry not, as the article very aptly covers all there is that you need to know about sovereign bonds and why they have emerged as this big a deal lately.
What exactly are sovereign bonds?: A bond is similar to an IOU. The issuer promises to pay back a fixed amount every year until the expiry of the term, at which point the issuer returns the entire principal amount to the buyer. When the government issues such a bond, it is called a sovereign bond. The more financially strong a country, the more well respected are the bond it issues. Simply put, sovereign bonds are government debt securities issued in the overseas markets in foreign currency denominations like the US Dollar, Euro, Yen, etc. Some of the best-known bonds are the United States of America’s Treasuries, Britain’s Gilts, France’s OATS, Germany’s bunds, and Japan’s JBGs.
Why has it become the word of today?: The reason why a sovereign bond issue by India has emerged as a big deal today is because the country has never resorted to a large-scale foreign currency borrowing, even at times like the Balance of Payments crisis of 1991 when the forex reserve of the country was so meagre that it could cover only two and a half month of imports in the economy. Even when the government was at the brink of defaulting severely, it secured an emergency loan from IMF by pledging 67 tons of India’s gold reserves as collateral. Even during tough times like the Asian crisis and the US sanctions after our Pokhran nuclear test, during the tremors of the Lehman Brothers fiasco, RBI governors from C Rangarajan to Bimal Jalan, Y V Reddy to D Subbarao and to now Raghuram Rajan, all have only advised against this foreign currency borrowing.
So, what is the need for an external borrowing in external currency now?: As announced by the Finance Minister, India plans to raise USD 10 billion from its first overseas sovereign bond. The biggest reason behind this move is that the Indian government’s domestic borrowing is hampering private investment and keeping the interest rates from falling even when inflation has cooled off a bit and the RBI is cutting the rates. Currently, 80-85% of domestic savings account for government borrowings. If the government would borrow some funds from outside then not only would the interest rates come down in the domestic markets but also, a good amount of funds would remain for the private companies to use, a much-needed measure in the sagging economy of today. In addition to this, India’s sovereign external debt to GDP is a meagre 5% which gives the government a wide scope to leverage this position to borrow further, without fretting a lot over the possible negative effects. Moreover, a sovereign bond issue would also set a yield curve benchmark for Indian companies that wish to raise loans from foreign markets. At last but not least, the timing for such an issue currently seems to be an ideal one. Owing to the easy foreign central banks’ policies, surplus funds await products that can offer them more and the low-interest rates in the economies from where the Indian government is likely to borrow, make the whole scenario a win-win for both the sides. The appetite of the international financial markets for Indian bonds and their prices would also act as a measure of how the Indian economy is viewed in terms of the risk factor, globally. To explain this further, for example, if the rate at which India can borrow in the external markets is low then, that would mean that foreign economies attach a low risk to India defaulting, thereby implying a positive outlook.
What are the risks involved?: The huge debate that India’s sovereign bond issue has sparked amongst leading economists and policymakers, amidst all the benefits stated above, obviously lead one to wonder what the possible glitches could be. Several people have raised their eyebrows over the issue dreading that India might fall prey to the same path that Central and South American countries like Mexico and Brazil followed back in the 1970s. Several such countries borrowed heavily in the external markets at the time when liquidity blossomed all across the globe, however, years down the line when their currencies depreciated, these countries landed themselves in a huge pile of debt they were not in a position to repay. Thus, foreign currency risk stands to be the biggest reason, as pointed out by former RBI Governor, Raghuram Rajan. In addition to this, India’s exchange rate volatility is much higher than the volatility in the yields of G-Secs. In simple terms, this means that even though the government might be borrowing at cheaper rates externally, but the eventual rates, incorporating rupee weakening against the dollar, might make the deal a pretty costly one. Also, owing to the fresh foreign currency pumped in the economy, the RBI would have to take stringent steps to suck out money supply from the economy so as to neutralize the effect of the newly added one. If not, then the excess money supply would push up the prices and set a cycle of inflationary pressure in motion. This would push up the interest rates further and thus, disincentivize private investments in the economy, thereby crippling a major engine of growth. Moreover, India is vulnerable to global economic risks and amidst the twin deficit problem, the cons attached to a sovereign debt issue need to be taken care of thoroughly. Also, as pointed out by many economists, if the tap is opened once, the government might get addicted to this form of funding, which could have severe consequences if not controlled.
What are the takeaways then?: The unpleasant examples set by emerging economies might make one apprehensive of the whole idea of foreign-denominated bonds. To top it up, it’s quite likely that the government might dip again into the foreign markets seeking loans each time it goes tight on the pockets. However, the disappointing tax revenues, India’s strong position to borrow funds from external markets, among a few other aforementioned reasons, make a sovereign bond issue just the right choice at present, provided the portion is small, there is a check on the borrowing and sufficient safeguards are set in place to regulate and monitor the use of the funds. For instance, the Centre could earmark transparently and directly, all the raised funds for funding a domestic developmental bank like IDBI, etc. These banks could also use these funds to lend to the private sector for economically viable projects that also generate exports in the adequate measure. The inflationary impact also could be brought down to a major extent by ensuring that these funds result in income-generating assets instead of finding their ways into other people’s pockets or developing deities or structures worth thousands of crores here and there. Ultimately, it all comes down into trust. And having built that trust well over 7 decades, it’s high time that India breaks out of this cage of rupee only government bonds and caters to its massive developmental needs of today.
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A highly driven and motivated individual, Aradhana is currently a B.Com undergrad at SRCC. Always on the lookout for being a better version of herself than yesyerday, Aradhana has always found her muse in pen & paper. We leave the rest for her articles to communicate to you about what buzzes around this budding writer’s head!