Indian Finance Minister (FM) Nirmala Sitharaman introduced her government’s latest policy move to issue sovereign bonds as a part of the 2019 budgetary proposal. According to government sources, the decision will prevent a crowd-out of private domestic investment in India. However, some experts are wary of the consequences that may follow.
India, with one of the lowest external debt to GDP ratios of less than 5%, has proposed raising some of its borrowing requirements in foreign currency. The government intends to borrow up to $10 billion in sovereign bonds which would constitute 10-15% of India’s total borrowing. The structuring of the bond will commence shortly and details of the issuance are due to be outlined in September, 2019.
The government is looking to reduce its dependence on domestic savings for its debt needs. Economic Affairs Secretary, Subhash Garg said that by raising foreign debt, the government hopes to ease the real interest rates in India in order to induce the private sector to step up investment. India has been experiencing a significant fall in private investment. The investment in new private sector projects has fallen by almost 89% compared to the last fiscal year and 83% compared to the last quarter. This shrinkage can be attributed to the liquidity shortage in the economy due to bad loans and non-performing assets.
Lower borrowing costs are another reason behind the decision to issue sovereign bonds. By turning to the international market, the government can also measure the international demand for Indian bonds. Sovereign bonds issued by emerging markets tend to be appealing to investors because of their high yield.
India has already found a potential ally in its sovereign bond issue. Former UK Prime Minister Theresa May recently stated, “When the Indian government raises its first-ever international sovereign bond later this year, I hope they do so in London - whose capital markets, with their unrivalled depth and liquidity, are the best in the world.”
However, this decision has come under intense scrutiny with experts claiming that the bond issue could drive the country into a debt trap that could worsen with a weakening rupee. A rupee depreciation will make debt repayments more expensive and hence, increase the country’s current account deficit. In fact, earlier considerations on sovereign bond issuances had been written off by the previous Finance Minister Arun Jaitley on grounds of exchange rate risk.
Former World Bank Senior Economist, Dr. Aniruddha Bonnerjee, informed BE, “The government rationale behind this move reflects inconsistent views about the Indian economy. On the one hand, it implies a pessimistic calibration of domestic options, and on the other, it shows a bullish optimism on its assessment of the international demand for Indian debt. Slowing economic growth as well as tepid revenue forecasts implies that domestic options to raise revenues are constrained – hence the purported need to explore low interest financial sources from international markets. On the other hand, the government thinks that the stable debt/GDP ratio and other macro fundamentals are robust for this issuance and could easily withstand the scrutiny of global credit agencies and other major actors and institutions in global markets. Furthermore, the rationale appears to be based on incomplete analysis. There has not been any logical reason put forward as to why domestic bonds were not an option and reflects an implicit preference to avoid ‘squeezing out’ effects and continuing the liquidity bubble.”
Once the government issues sovereign bonds, it will be induced to do so again. This will likely create a widening sovereign debt burden that will drain the country of its foreign reserves and lead to a downgrading of its sovereign ratings. Rating agency Fitch has assessed India’s sovereign debt as BBB-, which is the lowest on the investment grade scale.
Former RBI Governor, Raghuram Rajan stated that raising debt in foreign currency does not significantly affect the demand situation for domestic bonds, but instead, could expose India to other risks. He offered other solutions to improve the investment climate of the country, which included relaxing regulations on foreign investors in India. One must also consider the loss of sovereignty argument. The bond issue could potentially allow foreign institutions and governments to manipulate India’s policies. Former RBI Governor Y.V. Reddy said that these bonds are ‘sovereign liabilities in perpetuity’.
Previous sovereign bond issuances by other developing countries like Argentina, Pakistan and Greece had detrimental economic impacts. Yields on Argentine three year bonds hit a new high in April as the country fights high inflation rates that have made the peso the worst performing emerging market currency. Pakistan has also been facing a drain on their foreign exchange reserves to service their huge external debt. The country is now considering switching to non-debt flows like exports and investments to maintain their foreign reserves and has shifted its focus from sovereign bonds.
An IMF paper titled ‘International Sovereign Bonds by
Emerging Markets and Developing Economies: Drivers of Issuance and Spreads’ published in 2015 suggests EMDEs that opt for sovereign bond issuances have certain characteristics. These include larger economic size, higher GDP per capita, stronger macroeconomic fundamentals and government effectiveness.
Further, the primary bond yield spreads tend to be lower for countries with faster economic growth, favourable current account surpluses and international reserves.
India Ratings economist Sunil Kumar Saha has stressed the need to stabilise the economy even if it means a short-term increase in fiscal and current deficit. With unemployment in India at a 45-year high of 8.1%, the onus is on the government to fight the slowdown in the economic growth rate and consumer demand.