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Should India Go For Overseas Sovereign Bonds And Why Not?

Author: Rajiv Singh/Wednesday, August 7, 2019/Categories: Exclusive

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Should India Go For Overseas Sovereign Bonds And Why Not?

India runs a current account deficit and lacks significant natural resources that can be exported. India too has suffered financial crisis in the past, the 1991 balance of payments crisis is the most recent example. However, since then, India’s economy has undergone structural transformation, and didn’t suffer much during the Lehman crisis, despite India having progressively liberalized both its current as well as capital account regime since the mid 90’s. This was on account of economic reforms introduced by Manmohan Singh, and later on by NDA-1. India has seen significant inflows of capital in our equity and debt markets and large Indian corporate have been able to borrow abroad, as an example; Reliance Industries has issues a $100 million bond with tenure of 100 years.

However, there are genuine concerns that have been highlighted, for instance the Indian Rupee has depreciated on an average by 3% since 1994, and this means that the benefit of the interest rate differential may be wiped out by currency depreciation. The decline in the currency from 2010 to 2014 has been highlighted as well. India has a persistent current account deficit and this implies that India needs capital inflows, and any reversal in the direction of global capital flows can make India vulnerable. Another concern that has been highlighted is that an external sovereign issue may come with riders, reducing flexibility with regards to domestic economic policy.

CPI is currently around 3% in contrast to the double digit inflation earlier this decade. Similarly, the government has displayed commitment to fiscal prudence, and the central fiscal deficit is likely to decline below 3% of GDP in the coming years. Much of this improvement has been institutionalized, the RBI now has a mandate to maintain inflation in the 4% +/-2% range and the government has committed to fiscal prudence via the FRBM act.

The economic survey had highlighted that India needs to raise the rate of gross fixed capital formation in order to kick start a virtuous cycle of growth. Domestic savings are a challenge, so is the crowding out of the private sector by government borrowings. The consolidated fiscal deficit i.e. center and states combined is about 6.1% of GDP. Contrast this to net household financial savings of about 10.7% of GDP. This highlights the need to raise capital abroad, in order to allow room for the private sector space to raise capital. The government believes that an external sovereign issue would create room for companies to raise capital. The 10-year benchmark yield has declined from about 6.75% to 6.4% since the budget announcement.

To evaluate the risk of borrowing abroad, one needs to look at both stock as well as flow. India’s net international investment position (external liabilities-external assets) is pretty healthy at -16.2% of GDP. Many nations with external sovereign issue are bigger net debtors. For instance, Indonesia's net international investment position is -47% of GDP. India’s total external debt i.e. sovereign, NRI deposits and private sector combined totaled about $543 billion or 19.7% of GDP, which is low. Short-term debt (interest + principal due) made up 43% of this figure. Contrast this to total forex reserves of $407 billion in the same period. We note that some of these principal repayments would be refinanced. External debt servicing is 6.4% of GDP. This indicates that India has some room to raise money abroad. External sovereign debt is approximately 3.8% of GDP, again low and there is headroom to raise money abroad.

India has raised money before, in the form of resurgent India bonds in the 90’s, floated by SBI, which is often regarded as a proxy for India’s sovereign. Similarly, during the 'taper tantrum' of 2013, RBI floated a NRI deposit scheme. However, both of these were aimed at NRI’s. The current scheme would be aimed at raising money from sophisticated institutional investors. With US 10-yr treasury yields at 2.00% to 2.2%, the government hopes to attract money looking for yield. . Higher real interest rates, stable currency will trigger demand for our bonds by foreign portfolio investors. India’s credit rating was recently upgraded by Moody’s, and while Fitch and S&P have not upgraded, they too rank India as investment grade, which should be helpful. Emerging economies in their growth phase, require capital and domestic savings are lows and not sufficient to fund the same. Hence we need some foreign savings to fund growth. At the same time, huge borrowing by the government is putting pressure on interest rates and availability of funds for private sector and hurting growth. Foreign borrowing is one of the easier routes to fund capital expenditure or to reduce the deficit burden.

Once bonds start to trade on global platform, credit risk premium will be established and can also improve our rating as baseline is set. Ratings of Philippines, Indonesia and Malaysia have improved post issuance of global bonds in global currencies.

Currently, the US 10-yr bond trades around 2%, and our highest rated BBB- paper may yield 3%. One may feel they are available at lower cost if the borrowings are unhedged. As per Bloomberg survey, the proposed $10 billion issuance is expected to list at a premium of around 90 to 130 basis points. If the loans are unhedged, based on the historical currency depreciation rate, we may end up paying almost equal cost of the local borrowings. There are a few downsides, global participants are sensitive and dynamic; deterioration in macroeconomic stability will extract a toll. The government needs to keep inflation, fiscal deficit and current account deficit in check. This may oddly impose some discipline on policymakers. The Indian rupee may appreciate due to inflows which could hurt exports, hence the government needs to space out borrowings.

The RBI must exercise caution before opening up the limits for foreign players or borrowing money from global platforms. The RBI may need to intervene to minimize distortions in currency and sovereign bonds.

There some benefits for domestic markets. It will make it easier for MSME, retail borrowers as well as the state and local governments to borrow.

The government can issue INR denominated bonds (or Masala Bonds) externally or raise FPI limits in the domestic sovereign market. It should tread cautiously while issuing external sovereign bonds, and start issuing in low amounts – less than 0.5% of GDP, the proposed amount of $10 billion is within this threshold. Secondly, through a study of past crisis, it should place a cap on the total issuance as a percent of GDP in order to make sure that Indian bond issuance results more in the upside rather then become a crisis candidate. Lastly, through reforms, policy makers should focus on increasing exports as well as domestic savings. (The author is CEO - Stock Broking, Karvy)

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