The announcement of the substantial increase in government borrowings has again brought forth the debate on Sovereign Foreign Currency Debt. The proponents have been giving various arguments in favour of the issuance including lower costs of borrowing, diversified investor base etc. Those arguing against such an issuance have been highlighting the risks associated with foreign currency denominated borrowings. In this article we have analysed both kind of arguments in detail.
But let’s first understand what is meant by Foreign Currency Debt. Government of India finances a part of its expenditure by borrowing from debt markets. Till date, such borrowings have been rupee denominated in which both domestic and foreign investors have participated. Foreign currency denominated borrowings have been raised only from Multilateral Agencies( likes of World Bank, ADB etc.). Proponents in favour of such an issuance demand that India should start borrowing from other offshore investors as well in foreign denomination.
A very common argument which is given in favour of such an issuance is that the cost of borrowing for India will be lower if it borrows from global markets considering that yields have fallen off the cliff globally. If the government goes ahead with such an issuance, it will want to hedge the currency risks. The overall costs to the government including hedging costs are expected to be higher by at least 50-100 bps compared to domestic borrowing costs. So, the argument for lower direct costs definitely does not hold up.
Second argument which is given for foreign currency issuance is that it can increase the investor base for Indian government debt papers. Amongst foreign investors – only registered FPI investors are allowed to invest in Government debt papers in the present framework. However, a foreign currency denominated paper listed on a global exchange will allow potentially anyone to invest – thus increasing the demand for such papers which in long term will drive down the pricing as well. Ex-RBI Governor Dr Raghuram Rajan in his column brushed aside such potential lenders as “faddish investors”. This generalisation however may not be always true – for instance some large investors may have institutional policies allowing them to invest only in globally listed papers. This argument to a certain extent has been proven correct for corporate India where rationalisation of ECB framework has led to a significant surge in investor interest as highlighted in our earlier article. Such an issuance could also facilitate India’s inclusion in global debt indices over the course of time thereby enabling tens of billions of capital into the country. Thus, this particular pro-issuance argument deserves good merit.
Third argument given is that such an issuance will benefit corporate sector by easing the “crowding out” caused due to large government borrowings. This however needs to be analysed in a framework which incorporates the effect of such an issuance on currency as well. For example, in a scenario where rupee is appreciating, a foreign currency borrowing will further increase the inflow of dollars in the economy. This may force the RBI to buy these incremental dollars , the capital for which might be raised by selling its existing government bond holdings in the market. Thus, effectively the market doesn’t gain from such an external capital raise. On the other hand, in a scenario where the INR is depreciating, such an issuance might support rupee and in parallel ease out pressures on domestic bond markets. However, for India to be able to efficiently raise foreign denominated bonds in such a scenario will require a prior track record – hence the argument is given that India should have some presence in this market.
Coming to arguments made against such issuances, it is said that considering these bonds will be mostly held by foreign entities, any unfavourable event (for example an emerging market sell off) may lead to correlated selling causing yields at which these securities trade to shoot up. Such a risk is lower in FPI route since even if FPIs withdraw from the market the impact of such a withdrawal can be absorbed by domestic entities. This is because FPIs constitute just ~3% of the overall domestic bond issuance amount and rest is held by domestic entities. To clarify, the coupon of the already issued foreign currency denominated papers will remain the same for India and the direct impact of elevated yields will be to the investor holding those papers. In such a worse case scenario – India always has the option not to issue incremental papers in foreign markets and retreat back completely to domestic markets – which as it is country is doing now as well.
An unintended consequence of such an issuance can also be that FPI investors might shift their investments from domestic market to offshore issuances. This is because in FPI route it’s the foreign investor who bears the currency risk while in foreign currency denominated borrowing it’s the issuer who would be bearing it. It’s a valid concern and should be factored in as a cost while making the decision.
As can be seen above that, there are strong arguments for both the sides. Do the benefits outweigh the costs or is it vice versa ? – considering that there are too many variables, the net results are difficult to quantify. In such a scenario, India can benefit from the advice given by Prof. Ananth Narayan, SPJIMR when he says that India is the only major country not to have a single foreign sovereign bond which in his opinion is not correct.
Its possibly time for India to try out few such issuances, albeit smaller ones ,and thereafter decide on expanding or reducing the scale after cost-benefit analysis of these issued bonds – we cant be on the fence forever!