For nearly three decades, successive governments in India have baulked when it came to raising funds abroad through bond offerings by the sovereign even during periods of crisis. The Modi government has made a significant departure from an unstated policy for the sovereign not borrowing abroad by announcing that a part of its overall borrowings, which are normally carried out in India and are rupee denominated, will now be from the overseas markets. This will likely be used for infrastructure development. India’s bond market and other investors may have welcomed the move but it does pose risks too as some other emerging market peers have found out in the past.
The rationale is that India which has a low level of sovereign debt — or direct borrowings by the government — has the headroom now to raise money abroad. What this will do is open up the market in India to allow private firms to borrow in the space vacated by the government. This will help put the lid on higher interest rates at least in the near term. It does help that in the current juncture, global interest rates are low which would mean that a bond from a first-time issuer such as India with an attractive interest rate could woo investors.
China has been a frequent issuer of sovereign bonds, including for long tenures or maturities, but India has often highlighted the fact that it is far less vulnerable than many countries because it doesn’t borrow abroad. It will also mean the government is subjecting itself to greater fiscal discipline imposed by overseas investors and credit rating agencies.
Tapping the external market for raising funds has always been an option. Clearly, the government can borrow at much lower rates and create space for companies to raise funds domestically. But the flip side of the argument that more sovereign debt will make India vulnerable to external shocks has held back governments in the past.
Since 1991, foreign investment banks have pitched this idea with successive governments but the biggest resistance in the past has been from the RBI which had flagged risks inherent in this.
The risks include currency fluctuations, the impact of geo-political developments and domestic vulnerabilities including a worsening fiscal situation. A weakening of the rupee will thus be of concern not just to large Indian companies but to the government when it borrows abroad. The other issue is the utilisation of such foreign currency funds considering that a large chunk of rupee borrowings from the local market are utilised for paying salaries, pensions and interest payments.
In the past, the central bank had also cautioned against the sovereign raising foreign currency funds, citing the experience of Mexico, Turkey, Brazil — where after deterioration of finances, the countries had to approach multilateral lenders for assistance. The Vajpayee-led NDA government had also seriously considered issuing a sovereign bond especially during the East Asian crisis in 1998-99, but went by the central bank’s advice then, settling finally to raise substantial amounts through two borrowings by the State Bank of India. A couple of governors of the Indian central bank had fiercely opposed such a proposal in the past.
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The plan to borrow overseas may also be a growing recognition that domestic household savings may not be enough to absorb the borrowing needs of the entire public sector. Especially when the combined borrowing programme of the Centre, states and public sector enterprises has topped 9 per cent of GDP, leaving very little space for the private sector.
The bond markets has reason to cheer given the huge borrowing programme of the government. The relief was reflected in the10 year bond yields which fell below 6.6 per cent and closed finally at 6.69 per cent.
The government though is yet to indicate the percentage of borrowings through both rupee and foreign currency borrowings. One argument often put forward by bankers is that by borrowing abroad, the government will also help set a benchmark yield in the global markets for Indian borrowers. This could have implications for corporate borrowings abroad. A sovereign bond issuance can also help widen the foreign investor base for Indian bonds or debt.
What should be of interest is the handling of such a bond offering and the role of the Indian central bank, and the quantum of borrowings. The RBI is the country’s debt manager though the government is in the process of forming a separate debt management office.