Sovereign bonds may be a worthy experiment

NEW DELHI: Sovereign bonds, one of the pet themes of policymakers in 1990s, has staged a dramatic comeback of late. Issuing such bonds is almost like a coming-of-age ritual for the world’s aspiring economic powers. In the early 90s, the Indian government came very close to issuing dollar-denominated sovereign paper, but finally decided against it after dithering for some time.

Now the thinking in the finance ministry’s department of economic affairs is apparently that this is the right time to bite the bullet. However, one gets the feeling that the government sees the proposed float more as global posturing and the move is not linked to any financial consideration.

Currently, the country is sitting on huge reserves of foreign exchange and the government is finding it difficult to deploy these funds profitably. And the government’s fiscal position is strong and there is no urgent need for overseas sovereign borrowing.

By floating rupee-denominated sovereign bonds, the government may want to help the currency stake a claim to be among the globally accepted mediums of trade. This argument is backed by the fact that the government’s move was sparked off by the recommendations of an expert committee set up to suggest measures to make Mumbai a global financial hub.

According to reports, the finance ministry has a different take on the issue. At present, the government finances its deficit by issuing government securities in the domestic market. Sovereign bonds can reduce the cost of borrowing for the government. And for rupee-denominated bonds, the risk of threat from international creditors is non-existent.

The most important argument in favour of a sovereign float is that it can help Indian companies raise debt at lower interest rates from overseas market. A liquid market for sovereign bonds will provide international markets with a benchmark to judge Indian corporate paper. Access to overseas funds is vital for Indian companies planning global buyouts to achieve greater scale and market access.

However, some analysts are not willing to buy this argument. Jayesh Mehta, managing director & head, debt capital markets, DSP Merrill Lynch, says, “Blue-chip firms are already getting cheaper rates than their current rating entitles them to.

However, there is the advantage of a wider class of investors and abundance of funds. Many of the larger companies may find it difficult to borrow domestically because of single party exposure limits, so they may need to go abroad to raise funds as this gives them a wider investor base. If you take withholding tax and hedging cost into account, the foreign funds are not much cheaper.”

The most important concern over large-scale sovereign bond floats is that it will encourage the government’s financial profligacy. The fear is that cheaper funds may spark off internal mismanagement that could lead to an external crisis. There is the possibility of the government going in for exchange rate management with the help of sovereign funds.

However, such concerns seem out of place as the government may find it difficult to go back on the fiscal responsibility measures that are already in place. Also, one can take heart from the fact that the government’s thinly veiled programme of sovereign borrowing where it used State Bank’s intermediation did not have any disastrous effect on the economy.

The thinking within the government is that there would be great appetite for rupee-denominated sovereign bonds among fixed-income investors overseas which will help the government to raise cheap funds. The ministry’s view is that investors will lap up these bonds because of the government’s excellent debt repayment record. The government appears to be confident that it can raise funds at rates close to Libor. Issuance of sovereign bonds could also help widen the market for government paper.

A sovereign float will result in the creation of a new set of buyers in primary auctions as well as in the secondary market. A developed market for sovereign paper will be handy when RBI looks to reduce the SLR requirement for banks.

This will also help the central bank test the waters before going ahead with its plan for full convertibility of the rupee. The move may just be global posturing and may not result in any tangible economic benefit. But an overseas market for government bonds seems to be a worthy experiment that augurs well for future.