PART – 1
A bond is a fixed income product where in companies/countries can actually borrow money by issuing bonds in the market which retail or institutional investors subscribe to.
Think of it in this way, it is basically a form of a loan where in the subscribers to a bond issue can receive interest and principle at the maturity. Bonds can be of many times like zero coupon bonds (paying no interest but issued at discount and redeemed at full value at maturity), plain vanilla bonds etc. There are also other types of bonds like domestic bonds, foreign bonds, panda bonds, yankee bonds, euro bonds, global bonds, registered bonds etc. I will not delve deeper in the explanation of these types. There also exist inverse relation between bond prices and the interest rate (or the yield on the bond, in other words the total return you can expect from the bond if held till maturity).
The Indian debt/bond market is not mature or widespread or big (in absolute and relative terms) like the stock market. It is mainly consisting of majorly Indian government bonds and corporate bonds. Trading volume is increasing but still the market is tightly skewed towards institutional investors. The Indian bond market is depended on the fiscal as well as monetary policy stance taken by the government.
If we see the current Indian dynamic, the NBFC crises that has plagued the stocks of NBFCs and specifically has impacted the corporate debt market that has made the market opaquer. The Indian corporate debt market has largely been illiquid, and this crisis aggravated the structural problem of the market. Indian corporates in need of funds find it difficult to raise money from the debts and have to resort to equity financing (most expensive sources of funds), bank loans (NPA problems in banks and hence reluctant to lend to the private sector), foreign banks or debt issuances (foreign currency fluctuations) etc.
PART – 2
I was going through a book when I realized that it’s the time for the Budget speech by our first female full time Finance Minister Ms Nirmala Sitharaman on 5thJuly 2019.
I was happy to see how much emphasis she placed on strengthening of the Indian Bond market.
The bond market details and its nitty-gritties have already been discussed in the 1stPart of the series. If you haven’t read it, we recommend to go through that first which can be found in the most recent articles on the website.
The bond market is important for variety of reasons (again already discussed) but how the budget measures like allowing AA rated bonds for collateral purposes and sovereign borrowing from external sources will impact the markets will be explained in the coming paras.
External Bond Offering
The government has decided to borrow from external sources for their spending needs. What this means for us or the public? The government will tap the foreign investors and will issue foreign currency sovereign debt. This has been taken positively by the market which can be seen by the rally after these measures announced by the FM. The Economic Affairs secretary Subash Chandra Garg also announced that the government can borrow around $10 Billion which is roughly 10-15% of the total borrowing this fiscal.
- This is seen as positive by the market because this will actually help domestic funds be utilized by private investors which will lead to productive multiplicative affect and help the government achieve the $5 Trillion goal by 2024. This in market parlance is called the crowding out affect where the government crowds out private investors because of the former’s huge borrowing capacity.
- One more positive can be seen, if you are aware that governments all over the world are concerned about the global growth slow done and hence most of the yields or the interest rates have been negative (Germany) or very low (European Union countries) which will lead to lower cost of borrowing for the GoI.
- India has one of the highest cost of capital in the world. Due to government’s borrowing abroad, the crowding effect that was explained before will be prevented to an extent and hence the cost of borrowing will also come down which will again help to attract foreign and domestic private investors.
Some sceptics might point out about some of the disadvantages this can lead to.
- The most profound one is foreign currency risk. This can be explained by an illustration. If a government issues $US denominated bonds maturing in three years and after three years when the government has to redeem (zero coupon bond- explained by Part 1), the Rupee actually depreciated against the dollar, it will lead to higher cost for the government die to the unfavorable movement of the currencies. Now there is a solution, we can actually use hedging by buying Rupee futures or selling dollars or go for options, but these hedging techniques has substantial cost attached to them. Moreover hedging cannot hedge the entire exposure of the position taken by the Government.
- Another one can be the default risk by a domestic government against foreign borrowings (for e.g. Pakistan). This is the advantage of domestic borrowings against foreign borrowings. The government cannot default on the latter simply because it can print currency as ab when it needs (I know! I know! Inflation but that comes secondary of course).
The first one can be a little worrisome for the Indian government. The second one is not simply because Indian government has one of the lowest foreign debt to GDP (around 3.8%). Moreover, the Government has gigantic amount of foreign reserves, a record $427.7 billion from where it can service its foreign obligations.
This is one of the well thought out measure for the domestic debt market and which lead to ground level structural change in the Indian debt market. This will lead to a virtuous cycle of more debt issuance by corporates, more investments, more trading of these bonds in the market leading to the depth in the domestic bond market. This will lead to the lower cost of capital (debt being the least expensive) which is one of the most troubling bottlenecks to attract private investors and foreign private investors alike.