Question

India’s sovereign external debt to GDP (gross domestic product) is among the lowest globally at less than 5 per cent. Discuss in this context, whether India’s sovereign bond announcement in Budget 2019 a boon or bane?

Answer 1

Approach:

• Mention in brief, what is sovereign bond?
• To answer whether it is a boon or bane, try to bring in notice various pros and cons of sovereign bond. Make sure you deal with them in India’s perspective.
• Since no one is sure whether they will be successful or not, try to keep your conclusion balanced.

Sovereign bonds are fixed debt instruments issued by the government ,either in domestic or foreign currencies, which is like raising a loan in the international market. Sovereign Bonds have an interest outlay in the form of coupon payments where the principle amount is paid at maturity.

In India, the government has only issued sovereign bonds in local currency in the domestic market. Foreign portfolio investors have evinced interest in Indian government bonds traded locally in recent years, as the real interest rate on Indian bonds is attractive compared to other developed countries. But currency stability is vital for such investors, as they take the currency risk investing in rupee-denominated government bonds. This is where a foreign sovereign bond makes a big difference. A government bond issued in foreign currency (mostly in US dollars) shifts the currency risk from investor to issuer (in this case, the government).

Sovereign Bonds: A Boon?

• Higher foreign inflows: The issue of international sovereign bonds will have several long-term implications. It may facilitate the inclusion of India’s government bonds in the global debt indices. India’s representation in global debt market indices is small compared to other emerging markets. This may lead to higher foreign inflows into India.
• Free up domestic savings: They free up domestic savings to be channelled into productive private investments. They establish a benchmark that helps price discovery for other corporates tapping overseas credit markets.
• Rate of interest is low outside: India is among the few major countries globally to have never issued a sovereign bond. These sovereign issuances should be useful. They draw in foreign savings at a good rate for the country. With an advantage of lower interest rates abroad, the domestic market can be left for the private issuers.
• Discipline the government: foreign markets will discipline the government with integration in the global bonds market when Fiscal Responsibility and Budget Management (FRBM) rules are in place.
• Inclusion in global benchmarks would also improve the attractiveness of rupee-denominated sovereign bonds.

Sovereign Bonds: A Bane?

• Expose the economy to risks: Dollar-denominated bonds are more sensitive to global interest rates. Global shocks, as seen in the 2013 taper tantrums, can lead to heightened selling pressure on Indian bonds. Also Borrowing in foreign currencies may expose the economy to risks as the rupee's depreciation or current account deficit cannot be contained in the long run.
• Rising fiscal costs: The idea right now is being pushed to make up for tax revenue shortfalls but the intention of a long term borrowing is associated with growth led by investment and not short term needs. Therefore, a long time horizon cannot ensure or hedge against exchange rate risks, which increase the burden in repayment at the time of maturity.
• The impact of forex: Borrowing in international markets can reduce interest rates, but any change in foreign exchange (forex) can turn expensive. Countries like Mexico, Indonesia, Brazil and Russia have experienced massive pressure from international investors to repay debt.
• Original sin: It means a country cannot raise funds in its own currency in a foreign market, but has to borrow in dollars or euros. Moreover, as the US dollar is the resolve currency, it affects the market with greater implications.
• Although the step would integrate the Indian economy in global markets, it is debated that there is high risk involved. While the move is expected to ease the burden on Indian institutions, there are economies that have seen a bitter past in the global bond market. It remains to be seen whether history will be created or repeated in future.