Sovereign bonds: How to meet the budgetary ends with limited means

Updated: Aug 17, 2019 3:05 AM

The cacophony takes the debate back to the East Asian Crisis and reminds one of the implications of foreign inflows in the form of debt.

The sovereign bond issue might be an outcome of such deep thinking.The sovereign bond issue might be an outcome of such deep thinking.

By Sharad Kumar

This year’s Budget focused on Grameen Bharat, MSMEs and infrastructure—pillars towards reaching the $5-trillion economy goal. A non-populist Budget, it remained short of major direct tax proposals, but focused on development goals.

While achieving these goals could be an end, where are the means? With tax revenue growth having its own limitation, the dependence has been on off-budget borrowings, besides government borrowings. And with government borrowings already on the high side, the government think tank might have worked out a plausible option, especially when the fiscal prudence target is supposed to be kept sacrosanct. The sovereign bond issue might be an outcome of such deep thinking.

The finance minister said: “India’s sovereign external debt-to-GDP is among the lowest globally at less than 5%. The government would start raising a part of its gross borrowing programme in external markets in external currencies. This will also have beneficial impact on demand situation for the government securities in domestic market.” The beneficial impact had an obvious reference to the intent of easing the yields and interest rates. Many considered it as a change of style from the times when the government issued government bond in rupees and borrowed in foreign currency through designated bodies (on concessional rates) such as the World Bank. The government’s intent to have an offshore borrowing of 10-15% of total borrowing, working out to Rs 70,000 crore ($10 billion), got a mixed reaction.

The cacophony takes the debate back to the East Asian Crisis and reminds one of the implications of foreign inflows in the form of debt. The East Asian Crisis was followed by the Global Financial Crisis. While India remained largely unscathed, growth was supported by the four stimulus packages by the government in 2008-09. Strong domestic fundamentals and relatively low external debt helped, as there were no foreign obligations.

The study “The Impact of the Financial Crisis on Emerging Asia” by Morris Goldstein and Daniel Xie presented at the Asia Economic Policy Conference (2009) notes: “By contrast (and with the exception of Peru, Argentina and Venezuela), shares of foreign currency debt are low in Latin America and are particularly low in emerging Asia.” It acknowledged that the most striking feature is the low rollover risk in emerging Asia, relative to higher risk in emerging CIS and emerging European economies. Today, this low rollover risk in India is also due to its low dependence on sovereign foreign debt.

In a scenario where sovereign debt is expected to be priced 7.5% (assuming 3% coupon and 4.5% forward premium), much higher than the current yields on domestic bonds, it becomes a little ambitious to go for it, especially when there could be options to raise resources within. Though the domestic bond market is also subject to volatility and bond prices may move in tandem with factors that make sovereign bonds dearer, it does not provide a concrete case for not resorting to the traditional method of deficit financing.

Are there better options? An alternative could be revisiting the limit for FPIs to buy government bonds, revised upwards to 6% in FY20 by RBI. Currently, the limit for FPI investment in central government securities is Rs 3,384 billion for H1FY20. The utilisation so far has been Rs 2,063 billion, i.e. 61% with two months remaining for the first half year. This is against a utilisation level of 73% in the same period of FY19. Another alternative that has been exercised by some—like Kerala Infrastructure Investment Fund Board (KIIFB)—is masala bonds. These can take supply of money from international markets without incurring currency risk. The off-shore masala bond issue, denominated in rupee, would entail the investor bear the currency risk, with no requirement of currency hedge on the issuer side (unlike sovereign bonds). While this may also seem to be an option, the higher coupon would reduce the ‘masala’ element in such bonds. A better-rated company would be able to issue masala bonds at a better pricing, but so is the case if it floats a bond domestically. KIIFB had to pay 9.723% for its five-year masala bond—not a low number.

As Phil McGraw said: “Sometimes you make the right decision, sometimes you make the decision right.” We believe the government would take a call depending on market demand, pricing and acceptability—but with domestic financing as the primary option with further relaxation in FPI limits. In a developing economy like India where growth is being targeted, can we not afford a bit of fiscal slippage? India has slipped from the fastest growing economy to second fastest. It may, therefore, be pertinent to look at the broader picture and be flexible, than to micromanage.

The author is AGM-Economist, SBI. Views are personal

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