Raghuram Rajan Points Out Risks Of Issuing India’s First Sovereign Bond

In the Budget 2019, Finance Minister Nirmala Sitharaman proposed to issue India's first sovereign bond in the international market in external currencies. In simple terms, these bonds are fixed debt instruments that help a country's governments raise loans from the global market.

The decision to do so has been debated by several experts on the grounds that it comes with high risks.

What is debt-to-GDP ratio?

Like the name suggests, it is ratio of a country's public debt to its gross domestic product. The ratio also suggests a country's ability to pay its debts.

IMF data shows that as of 2017, the world's overall debt was estimated at $63 trillion and the United States makes up for one-third of that amount (31.8 percent). The US has roughly $20 trillion of government debt and finances its debts by issuing US treasuries, which are considered one of the safest bonds in the market. Taiwan, Hong Kong and Luxembourg are the three largest holders of the US Treasuries.

In terms of debt-to-GDP ratio, the US was at 103.08 percent in the second half of 2017. India's debt-to-GDP ratio was at 61.8 percent and Japan's at 249.1 percent (however, 90 percent of its debt was domestically raised) during the same time. China, on the other hand, had a lower debt-to-GDP ration of 16.5 percent.

Expert opinion

Sitharaman in her budget speech said that "India's sovereign external debt to GDP is among the lowest globally at less than 5 percent" and former RBI governor Raghuram Rajan feels that there was a rightful reason for this. "India's sovereign external debt is low precisely because past policymakers worried about the risks of issuing in foreign currency," he said in a column he wrote for the Times of India on Saturday.

He also quoted former Finance Minister Arun Jaitley's status paper on public debt published in February 2018 where he said that "Most of the debt is of domestic origin insulating the debt portfolio from currency risk. The limited external debt, almost entirely from official sources on concessional terms, provides safety from volatility in the international financial markets."

Arguing on Sithraman's second rationale on issue of the sovereign bonds-to have a positive impact on the demand situation for the government securities in domestic market, he said, "If the government wants to attract more foreign money to supplement domestic savings, it does not need to issue a sovereign bond, all it needs to do is to increase current ceilings on foreign portfolio investment into government rupee bonds. The effect is the same - more foreign inflows - but the government security is issued in rupees."

On the possibility of sovereign bonds will bring new investors from the international market, that were reluctant due to the registration hassles in India, he said, "We should worry about the nature of such investors. Might they be short term faddish investors, buying when India is "hot", and dumping us when it is not? Could the resulting volatility in India's debt traded on foreign exchanges then transmit to our domestic G-Sec market? Would the foreign tail wag the domestic dog?"

Rajan said that while bankers with suggestions of an Indian soveriegn bond in the international market are simply doing their job of earning fees for their banks, the Indian "government has to keep India's safety and needs in mind when sifting through their proposals."

"A small issuance will likely not be problematic. The concern is that once the door is opened, the government will be tempted to issue more, much more, with attendant risks - after all, all addictions start small," he added.

He further said that the bonds (which will be issued in international currency) will create unnecessary competition for rupee assets and the government should rather focus on making these assets more desirable and liquid to internationalise the rupee-that is, to make it a currency that other countries will use.

Three former RBI officials have also opposed the issue of the bond, saying the timing isn't ideal as India runs quite a large budget deficit.