The budget announced the government’s intent to tap overseas markets to raise debt.
Sovereign bonds, also called government securities, are debt instruments issued by a government to raise long-term funds with repayment obligations spread over years or in cases decades at a floating interest rate.
ET explains the significance of the move, how the yield pricing mechanism would work and why it has led to criticism from experts. 1.
What is the rationale for the government’s move? India’s sovereign debt at $103.8 billion is about 3.8 per cent of the GDP, while its external debtto-GDP ratio is among the lowest globally at less than 5 per cent.
The fact that the foreign debt was already low, added with factors such as cheaper interest rates on global currencies such as yen and dollar may have prompted the government to go for overseas sovereign bonds.
Additionally, such a move may also bolster private investments which have also witnessed a slowdown since the first half of previous fiscal.
“This will also have beneficial impact on demand situation for the government securities in domestic market,” finance minister Nirmala Sitharaman said during her budget speech.
As per market estimates, the government is planning to borrow 10 per cent to 15 per cent of its needs from overseas which works up to just over $10 billion. 2.
How are yields on sovereign bonds determined? The bond yields are determined by three factors: the creditworthiness or the ability of the issuing country to repay its obligations, the country risk marked by ongoing internal or external conflicts and the fluctuations in exchange rates in terms of the issuing currency. 3.
How would India’s sovereign bond be priced? The yield on US 10-year Treasury, which is also considered a global benchmark, currently stands at 2.04 per cent.
India is rated in the lowest of full investment grade by three major global rating agencies at BBB- by Standard - Poor’s and Fitch, and Baa2 by Moody’s — the same as Russia. As per a HDFC Bank report, this would price India’s yields around 175 bps (one basis point is 0.01 percentage points) over the US 10-year yields.
However, being the first such issuance by the country and given better external sector indicators, the spread on the yields may come at around 100bps.
In other words, the borrowing cost would be around 3.2 per cent with an additional 3.5 per cent to 4 per cent cost for currency depreciation which would take the overall repayment cost to around 7 per cent — a bit higher than the domestic borrowing cost, which currently stands at 6.4 per cent. 4.
What are the risks? The announcement resulted in criticism from various industry commentators.
Some believe that the depreciation cost of rupee may be too high and may cause the country to pay way more than it borrowed and eventually default as happened with Mexico in the 1970s and 80s. Others believe that the continuous flows to the foreign exchange kitty would make it difficult for countryto control its import and export rates.
“…times when the rupee depreciates significantly (such as during the Taper Tantrum) are times when India’s image amongst international investors is bad, and the higher repayment requirement on dollar debt could lead to even greater market turmoil,” wrote former RBI governor Raghuram Rajan in an op-ed piece for this publication.