Contents
What are Sovereign Bonds in India?
A bond is a debt instrument. It is issued by the govt. or a company to raise money. It is a fixed-income instrument where the issuer of the bond promises to pay the bank a fixed amount of money every year until the expiry of the term. On expiry, the issuer returns the principal amount to buyer.
Sovereign Bonds are bonds issued by the government of a country and is promised to be repaid by the national
government. It can be denominated in a foreign currency or the domestic currency. For example,Treasuries(USA), Gilts(Britain), OATS(France), JGB(Japan).
Need for issuing Sovereign Bonds in the external market in external currency
1. Low rate of interest: It would allow India to access cheaper funds from external markets. For instance, India can access the low-interest rates of the yen-denominated securities market.
2. Crowding out of private investment: Private sector needs to borrow adequately for investment. However, large
government borrowing results in less availability of funds for the private sector. This hampers the growth of the private sector.
3. High cost of borrowing:
- Indian government’s domestic borrowing leaves less amount of funds for private companies to borrow. Thus, the borrowing cost remains high even during phases of moderate inflation and RBI lowering its policy rate.
- If India borrows from the external market, it would free up capital in the domestic market for the private players and may result in a low cost of borrowing.
4. Low sovereign external debt to GDP ratio: India’s sovereign external debt to GDP ratio is among the lowest in the world(<5%). Thus, issuing sovereign bonds in the external market provides scope for the Indian government to raise funds without worrying too much about the possible negative effects.
5. Less amount of external borrowing
- It is estimated that the Indian government will raise about $10 billion from the external market.
- It would be just 10% of the gross market borrowing and 2.3% of current forex reserves. Thus, foreign borrowing would be a small part of the total borrowing.
6. Discipline the Government: Foreign market scrutiny will discipline the government and help to maintain financial prudence.
What are the challenges?
1. Currency Depreciation: Any depreciation in the rupee will make repaying the external debt more expensive.
2. Lessons from the past: Several economies were previously unable to repay their debt raised through external sovereign bonds. For example, Mexico, Brazil etc.
3. Stronger Rupee: Overseas borrowing may lead to an increase in India’s foreign exchange reserves. This will lead to an appreciation of the rupee, which will discourage exports.
4. Other options: As suggested by Raghuram Rajan, the government could access foreign money by using rupee-denominated bonds(for example, by raising the upper limit of foreign portfolio investment into government rupee bonds). This would have resulted in foreign inflows but with less risk of currency depreciation.
5. Risk of investor fleeing: Any change in the market situation may lead to mass fleeing of investors to other profitable markets. This may have a negative effect on the Indian capital market.
Way Forward
India has previously never issued a sovereign bond in the external market. It has its pros and cons. The step is expected to bring in private investments and free up capital. But a number of countries in the past have had a bad experience. Thus, India should take a measured approach and proceed cautiously.
