Govt must re-think on issuing foreign currency bonds

Media is agog with speculation that Economic Affairs and Finance Secretary Subhash Garg has been transferred to a low profile power ministry because he misjudged the consequences of India's external borrowing in dollar-denominated bonds. It was made a part of the Budget without adequate consultation with the stakeholders and a national debate on an issue that could land India into a debt trap.

Adding fuel to the fire were comments by people like Ashwani Mahajan of Swadesh Jagaran Manch, the economic wing of RSS, who became vocal on social media saying that Garg had been awarded for his ‘wonderful idea’ of sovereign borrowing. S Gurumurthy also opposed the idea. But, it may be wrong to squarely blame Garg for the Budget proposal for India's maiden overseas bond sale.

A day before the Union Budget, the economic survey talked of the low cost of foreign capital and an extremely benign interest rate abroad, which India must benefit from. Later, Chief Economic Adviser K Subramanian vociferously propagated his idea that the country must tap some foreign capital, which is at a premium and looking for an opportunity. The overseas capital may not be available to India at such a low rate of interest five years from now, he said. But what he did not say was probably more important. He stopped short of explaining that the current benign global financial conditions would not sustain in the long run and it could magnify the risk of flight of capital from India.

Economic Survey is a flagship document of the finance ministry that along with outlining challenges, recommends measures to overcome them. So, the idea has not come out of the blue and there must have been some discussion within the government before making it a part of the Budget speech of Finance Minister Nirmala Sitharaman.

Unprecedented move

Be that as it may, the idea to issue central government securities in foreign currency has never found favour in India because of the long-term risks associated with that. And when the government announced in this year's Budget that it would start raising part of its gross borrowing in external currencies, justifying that India’s sovereign external debt to GDP was among the lowest globally at less than 5%, many former Reserve Bank of India governors raised their eyebrows.

Former RBI Governor Raghuram Rajan was quick to react saying that foreign bankers often meet finance ministry officials, trying to persuade India to issue a foreign bond. Rajan said, in my experience, they usually started by saying that such borrowing would be cheaper because dollar or yen interest rates are lower than rupee interest rates. “This argument is bogus – usually the lower dollar interest rate is offset in the long run by higher principal repayments as the rupee depreciates against the dollar. Moreover, times when the rupee depreciates significantly (such as during the Taper Tantrum), are times when India’s image amongst international investors turns bad, and the higher repayment requirement on dollar debt could lead to even greater market turmoil. For this reason, most countries issue government debt in foreign currency only when they are unable to issue in their own currency.”

He even suggested that if the government wanted to attract more foreign money to supplement domestic savings, it did not need to issue a sovereign bond, all it needed to do was to increase current ceilings on foreign portfolio investment into government rupee bonds. The effect would be the same – more foreign inflows – but the government security would be issued in rupees. Soon, other former RBI chiefs joined the bandwagon. Among them were Y V Reddy and C Rangarajan.

One of the most important determinants for the issuances of foreign currency bonds is the government’s fiscal position. India has much higher consolidated fiscal deficit compared to most of the other emerging markets. According to Kotak securities, the government needed to have a clear strategy in terms of fiscal consolidation, quality of expenditure (greater allocation to public infrastructure such as education, health, roads), and transparency on off-budget spending as well as contingent liabilities to understand the degree of fiscal risks.

The Budget papers, on the contrary, have shown that India's off-budget borrowings have grown manifold this year. If all of that were incorporated in the budget, the fiscal deficit would have been much larger. After all the purpose of a government bond is to raise money to operate its functions and pay down its debt. Government debts are considered to be secure and therefore they should be based on strong fundamentals.

Historical experiences of countries with high exposure to foreign capital and weak macro fundamentals such as Argentina, Thailand, Brazil and Turkey among others have not been pleasant.

The moment India issues a dollar or yen or euro-denominated government security paper, it becomes more sensitive to global interest rates and in case of any global turmoil, it can lead to a higher selling of such bonds.