ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846
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Sovereign Bonds: Boon or Bane?

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The government proposed the issuance of an offshore sovereign bond in the Union Budget for 2019–20 on 5 July 2019. A sovereign bond is a bond issued by the federal government of a country with guaranteed periodic interest payments, also known as coupon payments, and repayment of the principal amount on the maturity date. In other words, it means that the government would borrow by raising a loan in the international market in foreign currencies. The government plans to borrow around $10 billion, which is about 10%–15% of the total borrowing offshore.

The investors who subscribe to such sovereign bonds include large global banks and a few countries. The rationale being put forth for the raising of such offshore sovereign bonds is that India’s total sovereign debt-to-GDP (gross domestic product) ratio is less than 5%, and it would have a favourable impact on the demand for government securities in the domestic market. The total sovereign debt at the end of the financial year 2018–19 was $103.8 billion, which was 3.8% of the GDP. Those in favour of issuance of such bonds argue that it would free up resources for domestic savings and production, and help establish a fair market price for Indian debt. It would establish a credit default swap (CDS) market that would aid in efficient price discovery. In addition, it would allow raising of cheap money abroad given that the bond yields in the international market are currently low. It would also attract substantial inflows into the local debt market from global investors.

Critics of sovereign bonds argue that the temptation to raise money in overseas markets in foreign currencies is a dangerous move fraught with risks that outweigh the perceived benefits. These bonds get exposed to global vulnerabilities and lead to the emergence of CDSs, which draws the attention of speculators. A CDS is a financial contract that allows an investor to “swap” or offset their credit risk with that of another investor. In the overseas markets, there are CDSs written by underwriters such as hedge funds and investment companies that do not hold the under­lying securities and resort to pure speculation. These CDSs are traded, leaving them susceptible to manipulation, and send signals to the local bond market.

During times of market upheaval, the offshore debt traded overseas would be subject to more vulnerabilities and their valuations would be hit harder than those of the onshore debt. In such turbulent situations, the Reserve Bank of India (RBI) and the government have the means to support the domestic markets, which, however, are out of bounds for the overseas markets. The signals by the overseas bonds may disrupt the domestic bonds, which are tightly controlled by the RBI. The overseas bonds would substantially erode the RBI’s freedom to manage interest rates and would dilute the debt manager role of the RBI.

Geopolitical tensions can prompt the foreign investors to short-sell their holdings of offshore sovereign bonds, which in turn can create panic in the domestic bond market. Offshore debt has to be repaid in foreign currency and any sharp depreciation of the rupee will potentially raise the borrowing cost from overseas in times of redemption. Even though the actual fiscal deficit was between 5% and 6% of the GDP during the last many years, after incorporating the off-budget borrowings, there has been financial stability in the economy as the country did not resort to any offshore sovereign bonds. Since independence, India has never issued an overseas sovereign bond. However, there were bonds issued by others that were guaranteed by the sovereign.

There are nations that have witnessed a bitter past in the global bond market. The Latin American debt crisis, also known as La Década Perdida, was a financial crisis that originated in the early 1980s whereby many Latin American countries—notably Mexico, Argentina and Brazil—were unable to repay their foreign debt. These countries allowed their sovereign borrowing to rise to 30%–40% of their GDP. The sovereign default of the Latin American nations had an adverse effect on their economies whereby unemployment rose to high levels, economic growth stagnated, incomes and imports dropped, and high inflation reduced the buying power of the middle classes.

Raising money through overseas bonds in external currencies may expose the economy to macroeconomic risks as the depreciation of the rupee cannot be kept under control over a longer period. The overseas bonds will increase the vulnerability to global financial markets’ volatility and uncertainty. In the case of rupee depreciation, the government would have to bear the potential high costs of devaluation upon repayment of the principal amount on the maturity date in external currency. It is recommended that the government avoid the issuance of offshore sovereign bonds and instead opt to raise debt from the domestic market to make up for any tax revenue shortfalls. It would also help if the current restrictions on foreign portfolio investment in domestic government bonds are relaxed.

Sudip Das

Bengaluru

Updated On : 6th Sep, 2019

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