Sovereign Bond Issue in “thanda basta”

Subhash Garg

 

The Union Budget proposal for a Sovereign Bond by India in the international markets might have come a cropper along with its “sherpa”, Subhash Garg, our former finance secretary.

Why the rush?

It was never apparent why the government chose to announce in the Budget speech this year, out of the blue, almost as an aside that “the government will start raising a part of its … borrowings in external markets in external currencies”. This is a departure from the strategy followed thus far, of veiling government borrowings by asking one of the publicly owned companies to borrow instead, backed by a sovereign guarantee. This is why India is already rated by international credit rating agencies.

Per convention, no new budget proposal comes sans an explicit  provision

The Budget speech usually announces headline changes proposed for the year under consideration. Why then was the receipt of such external debt not budgeted this time? The receipts for external debt are shown as a negative Rs 29 billion. This entry does not align with the subsequent informed speculation which pitched the bond at $10 billion.

Note that another “probable” receipt of dividends/surplus from the RBI, other nationalized banks and other publicly owned financial institutions, the government had no qualms in budgeting for a receipt of Rs 1.06 trillion — 43 per cent higher than in the previous year at Rs 0.74 trillion. This matter remains unresolved, though the Bimal Jalan Committee has completed its job.

Just another slip?

Clearly, the external borrowing was never neither seriously proposed nor discussed as a budgetary input. Divergence of the budgetary estimates from ground realities has pointed out earlier also by the commentariat. The chief economic adviser and the finance secretary used wildly different data for tax receipts in the past year — the Economic Survey, appropriately, relied on the most recent “provisional actual” data generated by the Controller General of Accounts — the government’s accountant. The Budget used the older and more optimistic “revised estimates”. Both the Economic Survey and the Budget are tabled in Parliament by the finance minister. This became a major embarrassment but was glossed over, it being the maiden Budget of Nirmala Sitharaman and the lack of chutzpah amongst the wilted ranks of the Opposition in the Lok Sabha.

Economist Rathin Roy, director of the NIPFP, a government think tank, has since the Budget been the foremost public critic of abandoning the earlier, veiled approach to foreign borrowing. The issue is complex.

Hakuna matata or fiscal stress?

India is not currently short on foreign exchange to meet its external obligations, so why borrow externally is one argument. Our “strong INR” policy pushes the Reserve Bank to maintain high forex reserves so that it can sell US dollars as required, to guard the INR against temporary forex volatility.

Increasing external debt binds us into the same corner as does importing 75 per cent of our petroleum requirements. Keeping the INR artificially strong reduces the burden that a realistically depreciated INR would otherwise impose on our fiscal stability via higher inflation and higher fiscal stress. In the case of external debt, INR depreciation on account of inflation differentials can vitiate the logic of foreign debt being available at low interest rates. The cost of the government’s domestic borrowing is around 6.5 per cent. An INR weakening by just four per cent per year can quickly wither the nominal interest differential.

But just as surely, we could hope for higher exports and lower non-oil imports. A depreciating INR would strengthen the competitiveness of our domestic manufacturers versus imports and lower the overseas landed cost of our exports.

Vacating space for private borrowings

The finance minister had argued that a sovereign bond could lower the cost of domestic borrowings. This was validated by a lowering of the yield (interest paid on face value of the bond) on 10-year government domestic bonds from 6.70 on Budget day to 6.33 per cent 10 days later in July. Similarly, vacating space in the domestic market can lower the cost of borrowing for private borrowers.

However, there is no shortage of liquidity for good private borrowers with viable projects. The real dampener in investment is the expectation that the RBI is likely to reduce the repo rate (rate at which RBI lends to banks) by another 0.50 per cent to 5.25 per cent by the end of FY 2019-20, over the 0.75 per cent reduction already effected, since governor Shaktikanta Das took office.

Shakti RBI

Expectations of lower interest rates hold back investments

Only around one eighth of the repo rate reduction of 0.75 per cent has been passed on to corporates and consumers. Banks are unlikely to do better till they have provided for their accumulated stressed assets. It consequently makes perfect sense for borrowers to put investments on hold till FY2020-21, by when banks might be able to revise the interest structure downwards. Consider also that existing borrowers do not automatically get the lower rates and the tendency to hold back makes further sense.

Is our balance sheet sound?

Is the timing suitable for an international Sovereign Bond? Consistent and high growth is a major kicker for higher demand and lower cost in the bond markets. Growth declined through the previous fiscal year and Q4 ended with 5.8 per cent growth. This has unraveled India’s growth story. The outlook for the current year is not exciting either, with seven per cent being the outside, optimistic assessment. Q1 data on growth for FY 2019-10 will be available by the end of August. It will be awaited with bated breath to substantiate the prospects, if any, of a revival.

Current account on knife edge

Exports India

Also, exports have been stagnant since FY 2011-12. Our vulnerabilities to external stress came into sharp focus with the spike in oil prices in the third quarter of FY 2013-14. Whilst stressed exports might also be on account of markets roiled by geopolitics, international investors have little appetite to babysit a bond offering and the coupon rate reflects any apprehensions that they might have on the ability of the borrower to service the debt.

Just a medium term intention?

FM Sitharaman 6

Despite the many reasons to say nay, a sovereign bond issue does signal that India is in a position to open its fiscal data to investor scrutiny. The Issue does not have to be done tomorrow. Consider that Saudi Arabia took over a year to decide when to list Saudi Aramco internationally. Instead, in April 2019 it opted for it’s first international Bond issue of US$ 12 billion, which raised US$100 billion of investor interest. Access to bond markets need to be finely tuned to optimize demand and a sizable portfolio built up to facilitate active trading and price discovery.  This is a medium term exercise.

Possibly, all this might actually have been discussed in the pre-Budget meetings and the Sovereign Bond issue tossed into the Budget speech more as an expression of medium-term intention rather than near-term intent. But then why not say so explicitly, in the spirit of transparency?

Adapted from the author’s opinion piece in The Asian Age, July 28, 2019 https://www.asianage.com/opinion/columnists/280719/vexed-sovereign-issues-what-is-the-fuss-about.html

 

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