While announcing India’s first Foreign bond issue in her maiden Budget speech, Finance Minister Nirmala Sitharaman, said “India’s sovereign external debt to GDP (gross domestic product) is among the lowest globally at less than 5 per cent. The government would start raising a part of its gross borrowing program in external markets in external currencies. This will also have beneficial impact on demand situation for the government securities in domestic market”, sending the bond markets rallying as the 10-year benchmark yield fell almost 12 basis points to 6.58%.
As per Economic Affairs and Finance Ministry officials the government plans to raise about 10% of its total borrowing requirements for Fiscal Year 2020, amounting to ~10 Billion USD, in foreign markets. This is expected to be announced in September when the government is likely to spell outs its H2 borrowing program.
This overseas borrowing proposal has drawn mixed reactions from the industry, with some backing the move as the right step to boost liquidity in the system and provide funding to the private sector, while others including Ex-RBI Governor Rajuram Rajan believe such a plan “has no real benefit and is fraught with risks”.
With some of its highest borrowing numbers in the recent years, $103 Billion in FY 20, the government believes that by relying on exclusively on domestic debt, it taps into 80% of the savings in the economy, leaving little room for private companies. As a result, private businesses are forced to shell out double digit interest rates on bank loans.
Therefore, financing part of its borrowing requirements from outside the country would leave more liquidity for the lenders to extend credit to the private sector to meet its borrowing requirements. Lack of low-cost funds available to the private sector is one of the biggest obstacles being faced by companies in India, hindering their growth prospects. This could also help support the slowing GDP by boosting overall economic activity in the country, as private sector spending increases.
As mentioned by the FM with one of the lowest external debt to GDP ratios at 5%, such an issue if done in moderation can bring out the potential advantages that are sought form the issue, without facing some of the risks typically associated with foreign borrowings. India also has one of the lowest foreign ownership of its sovereign debt, which is capped at 6% of total outstanding government debt. To provide perspective, about 40% of U.S. national debt is currently owned by foreign governments and investors. A low ownership of sovereign debt along with a relatively low debt to GDP ratio at 127% in 2017, which rank lower than most advanced and emerging economies, India is positioned perfectly to take advantage of such an offering if done in moderation.
Such an issue would also help the government reduce borrowing costs and take advantage of the low yields prevailing in some of the foreign markets. As per sources, the government is planning to raise the entire amount in one go in either Euro or Yen denominated papers. Positioning itself well to take advantage of the low or negative yields prevailing in these regions. This would help the government lower its cost on debt as compared to borrowing within the country.
A foreign sovereign bond issue would create a benchmark, which is currently not available, for future foreign currency denominated debt to be issued by Indian companies, creating a road map for Indian private and PSU companies to borrow abroad in the future in a private capacity. This would give some of the larger players in the private sector greater access to the global capital markets allowing them to diversify their sources of funding.
However, some believe that due to the deficit budget India runs along with its wider current account deficit, foreign borrowings could leave the country open and vulnerable to the cyclical nature of global markets and unprotected from the shocks of the global economy. India has largely been immune to such global events in the past. However, with foreign loans coming in, the country would be unprotected from global economic fluctuations in the future.
Any governments borrowing in local currency is generally considered less risky because as a last resort the government can print additional currency notes to meet any debt obligations. While this could lead to a decline in the value of the currency, the government would still be able to pay up on time and save itself from the embarrassment of, and more importantly from the catastrophic implications of default. However, in case of foreign currency denominated borrowing, a government does not have the ability to print foreign currency and therefore the risk of default is much higher. This has been seen several times in the past with several countries including Greece, Turkey, Ghana and Russia having defaulted in the past. Thus foreign debt is generally considered much risker, especially issued by developing countries.
Taking note from the 70’s, when the global markets were flushed with liquidity from the oil money several Latin American countries including Mexico, Argentina and Brazil, borrowed in Foreign countries to benefit from low interest costs. As Interest rates started rising so did the debt payments making it harder for the Latin countries to repay their debts. A depreciation of their currency relative to the Dollar did not make these payments any easier. During that period sixteen countries either defaulted or rescheduled their debt payments. Such a situation, given the expected quantum of overseas borrowing, seems unlikely however the consequences of such an event would be dire.
Another issue with a foreign borrowing is that, it would lead to a build up of foreign currency reserves which in turn would lead to an appreciating Rupee. This is not the most prudent outcome as the government looks to push exports and limit imports which benefit from a depreciation of the Indian National Rupee.
A foreign issue would also open up India’s book to scrutiny from foreign investors, which may not be very welcome by the government, as in the past it has enjoyed a relatively high degree of independence in budgetary and policy matters.
Such a move does not come without its fair share of confusion, with the finance secretary (dubbed the brainchild of this proposal) being abruptly transferred a few days after this announcement, to the PMO saying they preferred masala bonds (INR denominated debt issued in foreign markets) over a foreign currency denominated issue, to the finance minister finally coming out and saying rethinking of such a proposal was not a option. It still remains to be seen how this would play out and the final details of the issue, should the government decide to go ahead with the proposal. We will need to closely follow this space in the coming few months leading to the expected announcement in September.