The decision to shift the management of public debt from the Reserve Bank of India to a specialised debt office under the ministry of finance offers an opportunity to explore ways in which the costs and risks to the government are minimised. This article explores if it is not worthwhile to denominate a small portion of sovereign debt in foreign currency.
HT PAREKH FINANCE COLUMNoctober 11, 2008 EPW Economic & Political Weekly12Options to Consider in Public Debt ManagementSuman BeryThe views expressed here are personal.Suman Bery (sbery@ncaer.org) is with the National Council of Applied Economic Research, New Delhi.The decision to shift the management of public debt from the Reserve Bank of India to a specialised debt office under the ministry of finance offers an opportunity to explore ways in which the costs and risks to the government are minimised. This article explores if it is not worthwhile to denominate a small portion of sovereign debt in foreign currency. In crisis lies opportunity. As we in India observe the travails afflicting trans-Atlantic finance, we need to go beyond complacency and schadenfreude.The cor-rect approach is to see the current goings-on as a heaven-sent stress test, a natural experiment which shows us behaviour at the tails of the distribution. Correct analysis, though, is only half of the chal-lenge. Based on such sound analysis, we should look for and grasp the oppor-tunities presented by this clear shift in the global cycle. In this article, I focus on the opportuni-ties and implications of the crisis for managing India’s sovereign debt. In parti-cular I wish to explore whether the finance ministry should contemplate denominating some small portion of its sovereign debt in foreign currency, and if so to what degree.This is a good moment to examine this issue both because of developments over-seas, and because the management of public debt is due to migrate from the Reserve Bank of India to a specialised public debt office supervised by the ministry of finance. While details are not yet available, experience with such speci-alised debt offices in other countries sug-gests that the managers will be judged against a broad benchmark to be specified by the authorities. This benchmark is frequently couched in terms of minimising the cost of issue of public debt subject to an average maturity or rollover constraint. In mature markets of the Organisation for Economic Coop-eration and Development (such as Sweden and Ireland), the autonomous debt man-agement agency makes choices between fixed and floating rate debt, and on cur-rency of issue, much as is done by a so-phisticated treasury operation at a multi-national or at an international agency such as the World Bank or the Asian Development Bank. In the past, public debt management in India has tended to be extremely conser-vative, with an overwhelming preference for long-term, fixed-rate, rupee debt. This conservatism has been facilitated by two institutional features of the Indian finan-cial structure. First, statutory portfolio re-quirements of a range of institutions, from commercial banks to provident funds, provide a captive market for government debt. Second, the absence of active trad-ing across the maturity spectrum of gov-ernment debt inhibits the emergence of a true market-determined yield curve. Both phenomena are manifestations of mild fi nancial repression made possible through capital controls. It is certainly the case that this set of ar-rangements removes any serious rollover (maturity) risk for the government in meeting its funding objectives. What is less clear is whether these policies, on av-erage, raise or lower the overall cost of do-mestic funding of India’s large public debt. Nor is it clear that the duration of debt ab-sorbed by commercial banks, for example, is entirely suited to their treasury and portfolio needs, given the structure of their liabilities. The need for elaborate (and discretionary) accounting regula-tions, distinguishing between “Available for Sale” (AFS) and “Held to Maturity” (HTM) categories are indicators that the term structure of public debt held by the commercial banks is less than ideal given the structure of their liabilities. Any eas-ing of financial repression, along the lines proposed by innumerable committee re-ports (the NarasimhamI andII reports, the Percy Mistry report and the Raghuram Rajan report) is likely to have a powerful impact on the term structure of debt fromthe demand side, with implications for both cost and maturity that are difficult to predict. Currency CompositionLet me turn next to the currency composi-tion of the government’s liabilities. In India, by tradition, the sovereign has not itself issued foreign currency market debt(bonds), preferring to leave it to parastatals and public-sector banks to issue such paper as and when needed
HT PAREKH FINANCE COLUMNEconomic & Political Weekly EPW october 11, 200813for balance-of-payments purposes. The only foreign currency sovereign debt, accordingly, is non-traded international agency debt, even as non-sovereign for-eign currency debt, (in the form both of bank debt) and bonds (usually conver-tible) has risen steadily to take advantage of lower (presumably hedged) costs of borrowing overseas as opposed to the domestic market. India is not alone among sovereigns in shunning foreign currency market debt. Following foreign the currency debt crisis and default in the 1980s, the Brazilian Congress passed a law forbidding the treasury from issuing foreign currency bonds. At heart, the rationale for such a prohibition is sound: the main “asset” available to a sovereign is, almost by the very definition of “sovereign”, the power to tax. Since this taxation power is typically denominated in the home cur-rency (royalty payments on mineral wealth would be one exception), it makes sense for the sovereign primarily to incur domestic liabilities. In particular, the pow-er of monetary issue eliminates nominal default risk, while at the same time enhancing the probability of default through inflation.At this point let me stress that what I am not discussing here are issues connected with the nationality of the bond-holder. That debate, on the appropriate level of the ceiling on foreign institutional inves-tor (FII) holdings of government debt, has been discussed extensively in many com-mittee reports. My issue here is a separate, though related one, namely, to examine whether there are circumstances (includ-ing the present) when the sovereign might actively wish to assume foreign exchange risk. In this sense, my topic is more related to the recent literature on so-called “origi-nal sin”, largely inspired by the experience of Latin America. That literature argues that much of the travail suffered by Latin American countries in the 1980s and 1990s arose from currency mismatches. Long-term debt (both sovereign and cor-porate) was only available in foreign cur-rency, leaving borrowers vulnerable when the domestic currency depreciated. Here, too, then, is a caution against the perils of currency mismatches in the public and national balance sheets.The interesting question, however, is how this orthodoxy might need to be adjusted to reflect the circumstances of large Asian countries, particularly at the present juncture. Here, I am indebted to a series of papers by Philip Lane (of Trinity College, Dublin) and a series of his co-authors piecing together data on the national balance sheet of a number of countries, and, more recently, the cur-rency composition of their foreign assets and liabilities.1 The underlying point is a simple but important one: currency changes can have a sizeable impact on capital gains (and losses), that need to be factored into the true cost of finance, for a government as much as a private corpora-tion. The case is most simply and graphi-cally made by looking at the plight of China, which has huge foreign currency assets largely funded by domestic liabili-ties. As a consequence, depreciation of the dollar against the RMB stands to in-flict substantial capital losses on the con-solidated public sector, which is the ulti-mate owner of these reserves. If a portion of China’s debt obligations were also to be denominated in foreign currency, capital gains on that debt would partially offset capital losses on the asset side. In the caseof China, domestic funding costs are relatively close to international borrow-ing rates. In India, domestic interest rates have for some time been much higher than international rates, and are likely to remain so.This is where the current international scenario becomes relevant. Global interest rates are low and probably heading lower. The short-term direction of the rupee is difficult to predict, but the medium-term trend is likely to be one of appreciation. Even though the absolute amount is con-siderably smaller, at around 30 per cent of GDP, India’s stock of foreign exchange re-serves are substantial, and a potential source of both capital gains and losses. I am not arguing that the government ought to be opportunistic, or to be a market timer. The point is rather to exploit the shift of the debt management function and this particular moment in global financial affairs to develop a debt strategy which uses a wide array of instruments to reduce the cost and risk of meeting government’s funding needs.Note1 See Philip R Lane and Jay C Stambaugh, ‘Financial Exchange Rates and International Currency Exposures’, Discussion Paper No 229, Institute for International Integration Studies, Dublin, September 2007.NATIONAL INSTITUTE OF SECURITIES MARKETSFaculty PositionsNISM invites applications for policy research and postgraduate teaching positions. The candidates should have Ph.D in finance, management (with finance specialization) or financial economics from highly reputed institutes from India/abroad. The candidates should have published in top class international journals or demonstrate the potential for high quality research. The positions are available on full-time contract and fractional basis. It is also possible to provide flexible working conditions. Compensation would be internationally competitive. In exceptional cases, masters degree holders in these subjects can be considered for teaching positions if they have relevant and adequate experience in securities markets.Interested persons may e-mail their application to hrd@nismindia.com Please see www.nismindia.com for more details.
HT PAREKH FINANCE COLUMNoctober 11, 2008 EPW Economic & Political Weekly12Options to Consider in Public Debt ManagementSuman BeryThe views expressed here are personal.Suman Bery (sbery@ncaer.org) is with the National Council of Applied Economic Research, New Delhi.The decision to shift the management of public debt from the Reserve Bank of India to a specialised debt office under the ministry of finance offers an opportunity to explore ways in which the costs and risks to the government are minimised. This article explores if it is not worthwhile to denominate a small portion of sovereign debt in foreign currency. In crisis lies opportunity. As we in India observe the travails afflicting trans-Atlantic finance, we need to go beyond complacency and schadenfreude.The cor-rect approach is to see the current goings-on as a heaven-sent stress test, a natural experiment which shows us behaviour at the tails of the distribution. Correct analysis, though, is only half of the chal-lenge. Based on such sound analysis, we should look for and grasp the oppor-tunities presented by this clear shift in the global cycle. In this article, I focus on the opportuni-ties and implications of the crisis for managing India’s sovereign debt. In parti-cular I wish to explore whether the finance ministry should contemplate denominating some small portion of its sovereign debt in foreign currency, and if so to what degree.This is a good moment to examine this issue both because of developments over-seas, and because the management of public debt is due to migrate from the Reserve Bank of India to a specialised public debt office supervised by the ministry of finance. While details are not yet available, experience with such speci-alised debt offices in other countries sug-gests that the managers will be judged against a broad benchmark to be specified by the authorities. This benchmark is frequently couched in terms of minimising the cost of issue of public debt subject to an average maturity or rollover constraint. In mature markets of the Organisation for Economic Coop-eration and Development (such as Sweden and Ireland), the autonomous debt man-agement agency makes choices between fixed and floating rate debt, and on cur-rency of issue, much as is done by a so-phisticated treasury operation at a multi-national or at an international agency such as the World Bank or the Asian Development Bank. In the past, public debt management in India has tended to be extremely conser-vative, with an overwhelming preference for long-term, fixed-rate, rupee debt. This conservatism has been facilitated by two institutional features of the Indian finan-cial structure. First, statutory portfolio re-quirements of a range of institutions, from commercial banks to provident funds, provide a captive market for government debt. Second, the absence of active trad-ing across the maturity spectrum of gov-ernment debt inhibits the emergence of a true market-determined yield curve. Both phenomena are manifestations of mild fi nancial repression made possible through capital controls. It is certainly the case that this set of ar-rangements removes any serious rollover (maturity) risk for the government in meeting its funding objectives. What is less clear is whether these policies, on av-erage, raise or lower the overall cost of do-mestic funding of India’s large public debt. Nor is it clear that the duration of debt ab-sorbed by commercial banks, for example, is entirely suited to their treasury and portfolio needs, given the structure of their liabilities. The need for elaborate (and discretionary) accounting regula-tions, distinguishing between “Available for Sale” (AFS) and “Held to Maturity” (HTM) categories are indicators that the term structure of public debt held by the commercial banks is less than ideal given the structure of their liabilities. Any eas-ing of financial repression, along the lines proposed by innumerable committee re-ports (the NarasimhamI andII reports, the Percy Mistry report and the Raghuram Rajan report) is likely to have a powerful impact on the term structure of debt fromthe demand side, with implications for both cost and maturity that are difficult to predict. Currency CompositionLet me turn next to the currency composi-tion of the government’s liabilities. In India, by tradition, the sovereign has not itself issued foreign currency market debt(bonds), preferring to leave it to parastatals and public-sector banks to issue such paper as and when needed 
HT PAREKH FINANCE COLUMNEconomic & Political Weekly EPW october 11, 200813for balance-of-payments purposes. The only foreign currency sovereign debt, accordingly, is non-traded international agency debt, even as non-sovereign for-eign currency debt, (in the form both of bank debt) and bonds (usually conver-tible) has risen steadily to take advantage of lower (presumably hedged) costs of borrowing overseas as opposed to the domestic market. India is not alone among sovereigns in shunning foreign currency market debt. Following foreign the currency debt crisis and default in the 1980s, the Brazilian Congress passed a law forbidding the treasury from issuing foreign currency bonds. At heart, the rationale for such a prohibition is sound: the main “asset” available to a sovereign is, almost by the very definition of “sovereign”, the power to tax. Since this taxation power is typically denominated in the home cur-rency (royalty payments on mineral wealth would be one exception), it makes sense for the sovereign primarily to incur domestic liabilities. In particular, the pow-er of monetary issue eliminates nominal default risk, while at the same time enhancing the probability of default through inflation.At this point let me stress that what I am not discussing here are issues connected with the nationality of the bond-holder. That debate, on the appropriate level of the ceiling on foreign institutional inves-tor (FII) holdings of government debt, has been discussed extensively in many com-mittee reports. My issue here is a separate, though related one, namely, to examine whether there are circumstances (includ-ing the present) when the sovereign might actively wish to assume foreign exchange risk. In this sense, my topic is more related to the recent literature on so-called “origi-nal sin”, largely inspired by the experience of Latin America. That literature argues that much of the travail suffered by Latin American countries in the 1980s and 1990s arose from currency mismatches. Long-term debt (both sovereign and cor-porate) was only available in foreign cur-rency, leaving borrowers vulnerable when the domestic currency depreciated. Here, too, then, is a caution against the perils of currency mismatches in the public and national balance sheets.The interesting question, however, is how this orthodoxy might need to be adjusted to reflect the circumstances of large Asian countries, particularly at the present juncture. Here, I am indebted to a series of papers by Philip Lane (of Trinity College, Dublin) and a series of his co-authors piecing together data on the national balance sheet of a number of countries, and, more recently, the cur-rency composition of their foreign assets and liabilities.1 The underlying point is a simple but important one: currency changes can have a sizeable impact on capital gains (and losses), that need to be factored into the true cost of finance, for a government as much as a private corpora-tion. The case is most simply and graphi-cally made by looking at the plight of China, which has huge foreign currency assets largely funded by domestic liabili-ties. As a consequence, depreciation of the dollar against the RMB stands to in-flict substantial capital losses on the con-solidated public sector, which is the ulti-mate owner of these reserves. If a portion of China’s debt obligations were also to be denominated in foreign currency, capital gains on that debt would partially offset capital losses on the asset side. In the caseof China, domestic funding costs are relatively close to international borrow-ing rates. In India, domestic interest rates have for some time been much higher than international rates, and are likely to remain so.This is where the current international scenario becomes relevant. Global interest rates are low and probably heading lower. The short-term direction of the rupee is difficult to predict, but the medium-term trend is likely to be one of appreciation. Even though the absolute amount is con-siderably smaller, at around 30 per cent of GDP, India’s stock of foreign exchange re-serves are substantial, and a potential source of both capital gains and losses. I am not arguing that the government ought to be opportunistic, or to be a market timer. The point is rather to exploit the shift of the debt management function and this particular moment in global financial affairs to develop a debt strategy which uses a wide array of instruments to reduce the cost and risk of meeting government’s funding needs.Note1 See Philip R Lane and Jay C Stambaugh, ‘Financial Exchange Rates and International Currency Exposures’, Discussion Paper No 229, Institute for International Integration Studies, Dublin, September 2007.NATIONAL INSTITUTE OF SECURITIES MARKETSFaculty PositionsNISM invites applications for policy research and postgraduate teaching positions. The candidates should have Ph.D in finance, management (with finance specialization) or financial economics from highly reputed institutes from India/abroad. The candidates should have published in top class international journals or demonstrate the potential for high quality research. The positions are available on full-time contract and fractional basis. It is also possible to provide flexible working conditions. Compensation would be internationally competitive. In exceptional cases, masters degree holders in these subjects can be considered for teaching positions if they have relevant and adequate experience in securities markets.Interested persons may e-mail their application to hrd@nismindia.com Please see www.nismindia.com for more details.
