Sovereign Bonds

A sovereign bond is a debt security issued by a national government to raise money for financing government programs, paying down old debt, paying interest on current debt, and any other government spending needs. Sovereign bonds are a source of government financing alongside tax revenue.
Sovereign bonds can be denominated in a foreign currency or the government’s domestic currency.

Types of Sovereign bonds

• Treasury Bills (T-Bills): These are short-term debt instruments with a maturity of up to one year. T-bills are issued at a discount to face value and do not pay any interest. It is used to finance short-term borrowing requirements of the government.
• Government-Dated Securities (G-Secs): These are long-term debt instruments with a maturity of more than one year. G-Secs are issued at face value and pay periodic interest to the bondholders. They are the most common type of sovereign bond issued in India.
• Fixed-Rate Sovereign Bonds: Fixed-rate sovereign bonds pay a fixed interest rate, also known as the coupon rate, over the bond’s life. The interest payments are typically made semi-annually or annually. It provides investors with a stable and predictable income stream. Fixed-rate bonds are affected by interest rate fluctuations, which can cause their market value to rise or fall.
• Inflation-Linked Sovereign Bonds: Inflation-linked sovereign bonds, also known as inflation-indexed bonds or real return bonds. It is designed to protect investors from the adverse effects of inflation. Inflation-linked sovereign bonds are adjusted according to Consumer Price Index (CPI).As a result, the income generated by inflation-linked bonds protects investors against inflation.
• Zero-Coupon Sovereign Bonds: Zero-coupon sovereign bonds do not pay periodic interest payments like traditional fixed-rate or inflation-linked bonds. These bonds are issued at a discount to their face value, and investors receive the full face value upon maturity. Zero-coupon bonds are a better option for investors who prefer a long-term investment without the need for regular income.
• Foreign Currency-Denominated Sovereign Bonds: This type of sovereign bond can help a government raise funds from international investors. However, foreign currency-denominated bonds expose both the issuer and the investor to currency risk, which arises from fluctuations in exchange rates.
• Floating-Rate Sovereign Bonds: Floating-rate sovereign bonds have variable interest rates that adjust periodically based on a reference rate. The interest payments on floating-rate bonds rise or fall with changes in the reference rate, providing investors with some protection against interest rate risk.
• Sovereign gold bonds: Resident Indian entities including individuals (in his capacity as such individual, or on behalf of a minor child, or jointly with any other individual.), HUFs, Trusts, Universities, and Charitable Institutions can invest in such bonds. The tenor of the Bond will be for a period of 8 years with an exit option from the 5th year to be exercised on the interest payment dates.
• Sovereign green bonds: According to the World Bank, a green bond is a debt security issued to raise money for initiatives relevant to the environment or the climate. It can be issued by companies, countries and multilateral organisations to fund projects which have a positive impact on climate. It can be used to finance solar energy, hydro energy, renewable energy etc.
• Masala Bond: Masala Bonds were introduced in India in 2014 by International Finance Corporation (IFC). The IFC issued the first masala bonds in India to fund infrastructure projects. Indian entities or companies issue masala bonds outside India to raise money. The issue of these bonds is in Indian currency rather than local currency. Thus, the investor will bear the loss if the rupee rate falls.

India’s current status

• In budget 2022-23, Finance Minister Nirmala Sitaraman announced, the Centre will borrow Rs 15.43 lakh crore from the markets in 2023-24 to finance its fiscal deficit of 5.9 per cent of Gross Domestic Product.
• On a net basis, the Centre’s borrowing for the financial year 2023-24 has been pegged at Rs 11.8 lakh crore, up from Rs 11.19 lakh crore in 2022-23.
• The yield on India’s benchmark 10-year government bond fell  to 7.26%
• The government will also set up an Urban Infrastructure Development Fund (UIDF), which will be managed by the National Housing Bank and can be used by public agencies to create urban infrastructure in tier-II and tier-III cities.
• In the Financial year 2022-23, the yield on the government securities, especially on the benchmark bonds has risen more than 7 per cent.
• The rise in yields in 2022 was witnessed due to higher borrowing figures announced by the government in the previous budget and aggressive rate hikes by the central bank across the globe, including the Reserve Bank of India (RBI).

Pros of Sovereign bonds

• Attracting foreign investment: Sovereign bonds helps in attracting foreign investment into nation’s debt markets. It helps in financing the country’s borrowing requirements and support economic growth.
  Foreign investors have bought government bonds worth 152.50 billion rupees ($1.85 billion) on a net basis since November.(As per latest report published on 29th march 2023)
• Diversification: Sovereign bonds provides investors with diversification benefits, as they offer exposure to the Indian government’s credit risk and complements other types of fixed income investments.
• Lower default risk: Sovereign bonds are generally considered to have lower default risk compared to corporate bonds or other types of debt securities, as they are backed by the government.
• Liquidity: Sovereign bonds are traded on the Indian debt markets; it provides investors with liquidity and ease of buying and selling.

Cons of Sovereign Bonds

• Interest rate risk: Sovereign bonds are sensitive to changes in interest rates. When the interest rate rises, there is a decline in the debt market. While interest rates don’t directly impact your credit score, there is the potential for an indirect effect on your score as rates rise. Higher interest rates mean you’ll be paying more in interest accrual which can lead to growing debt if you’re unable to pay down the principal and interest in full each month.
• Inflation risk: Inflation can erode the purchasing power of the interest income earned on sovereign bonds, and it can be a major issue for investors.
• Currency risk: For foreign investors, there is the risk of currency fluctuations that can impact the value of the bond and the return on investment.
• Low yields: The yields on sovereign bonds in India have generally been lower than those of other emerging market economies. It can be a major issue for foreign as well as Indian investors.
• Credit risk: Although sovereign bonds are generally considered to have lower default risk. But during an unforeseen situation like a natural disaster or economic crisis government can default on its debt obligation.