RBI warns on sovereign bond issue, governent in a fix

MUMBAI: Issuing sovereign bonds in order to increase dollar inflows may compromise India's financial stability in the long run, Reserve Bank of India has said complicating the government's efforts to raise money from overseas markets to arrest the rupee's alarming slide in the past three months.

Reserve Bank of India governor D Subbarao said on Tuesday that a sovereign bond issue may not be good for the long-term financial stability of the country as it could further increase external indebtedness making it more vulnerable to external shocks.

Policy-makers have been considering the idea of issuing sovereign bonds to overseas investors and attract dollar inflows after the current account deficit crossed 5% of GDP and the rupee plumbed all-time lows this year.

The Indian currency has lost 9% since May 22, after US Federal Reserve chief Ben Bernanke indicated that it may slow down the pace of bond purchases. The statement caused a major sell-off in emerging market assets as foreign investors shifted to safe-haven assets like the US treasuries where yields rose to multi-year high.

"We have reservations about that," said Subbarao at a press conference in Mumbai after the Reserve Bank's mid-quarter monetary policy review. "There are costs. It will compromise our financial stability. There is a lot of value to be attached to government's borrowing in the domestic market. We have learnt that lesson. Emerging economies are not as unsafe as they would have been because the borrowing has been domestic."

In the past, government has raised dollar funds by way of issuing non-resident Indian bonds, though India has yet to issue a sovereign bond.

In 1991, government raised $1.6 billion through India development bonds, $ 4.2 billion through Resurgent India Bonds in 1998 and $5.5 billion through India Millennium Bonds in 2000.

Another problem with a sovereign bond is the price that the government would have to pay. The yield on Asian peer nations' US dollar-denominated or equivalent bonds has climbed in the past few weeks.

The Philippines' sovereign bonds are trading at 3.7% and Indonesia, which runs a similar current account deficit like India, is at 4.6%, Bloomberg data shows. If India decides to hedge the currency risk, the cost may soar to 9%.