What is this brouhaha about overseas bonds?

The Budget proposal to float an overseas sovereign bond has generated much controversy. If the government does go ahead, it will be a first for India. But the government is having second thoughts, and the plan may be all but shelved, at least for now.

What is a sovereign bond?

A sovereign bond is a debt instrument issued by a national government. In plain words, the government seeks to borrow money. It can be issued in domestic or foreign currency. Debt markets are an important source of funds, especially for a developing economy like India. India's debt market is one of the largest in Asia. An important feature of the Indian debt market is that the return is fixed and, therefore, risk-free. Any kind of bond floated by the government aids its expenditure.

So, why the clamour over the foreign sovereign bond plan?

In Budget 2019-20, Finance Minister Nirmala Sitharaman proposed a plan to issue an overseas sovereign bond. Initially, it was signalled that the government sought to raise $10 billion between October and March, in multiple currencies, but the government has subsequently said it has not determined how much debt it wants to raise. The proposal was contested by many economists, including former RBI governor Raghuram Rajan, and a few within the government because of its long-term risks as it involves foreign currencies. The critics say it will adversely affect domestic forex markets, liquidity and even equity markets in a time of global or domestic stress. When finance secretary Subash Chandra Garg, seen to have championed the bond idea, was moved to the power ministry immediately after the Budget and he, instead, sought voluntary retirement, it was speculated that the government would drop the plan. Then it was rumoured that the government wanted to have a wider discussion before taking a decision. The latest is that the government is going ahead, but slowly -- raising debt in tranches. In the past, India has always issued only domestic bonds.

You mean, the government put the plan into the Budget without thinking about it?

Currently, the global liquidity conditions appear robust and interest rate regimes are extremely benign. Those backing the plan thought they would make use of those conditions. The move could have lessened government borrowing and taken some pressure off the domestic debt market, which could, in turn, have benefited private sector borrowers.

That sounds logical, given limited domestic resources and the liquidity crunch.

On the face of it, the overseas bond does sound well-reasoned, but the risks involved are big. India has a twin-deficit problem. It has a larger fiscal deficit than other emerging market economies and it has a wider current account deficit, too. The government raises debt to finance these deficits. So long as it is in the domestic currency, the interest rate variation can be managed. But interest rates on foreign currencies are not under our control and they may not be as low as they are today. There is also currency volatility, in the event of any external shock, to consider. Secondly, loans in a foreign currency, say dollars, would have to be returned in dollars only. If during the tenure of the loan, the rupee weakens against the dollar, it would mean more rupees will have to be forked out to pay back the same amount of dollars.

What are the advantages?

It is cost-effective to raise capital when the interest rate regime abroad is benign. Sovereign bonds get international status and it makes it easier for the private sector, too, to access loans from the international market. But sovereign bonds of financially strong countries are more respected. Treasuries of United States, Gilts of Britain and OATS of France are some of the examples. Since India's sovereign external debt to GDP ratio is less than 5%, or the lowest globally, external loans in a small measure would not cause much harm. But countries have developed such borrowing into a habit and fallen into a debt trap. Argentina, Turkey, Greece, Brazil, Thailand and even Russia have defaulted on their sovereign debts. India must guard against that possibility.