In the 2019 full-budget, the Union Finance Minister had announced the issue of Sovereign Bonds. Sovereign bonds would reduce the pressure on the domestic bond markets (considering the government’s heavy borrowing program) and also ensure that dollars flowed into India. This was a brave move as India had never done an issue of sovereign bonds in the past. Interestingly, less than a month after the announcement, the government decided to go slow on the sovereign bond issue. Several economists raised concerns over the risks of a sovereign bond issue. Meanwhile, the PMO asked the Finance Ministry to do a rethink on the subject. At least, for now, the sovereign bond plan appears to be off the table.

Understanding what sovereign bonds are all about

Sovereign bond are debt issued by the central government of a country in a foreign market and denominated in foreign currency. For example, the Indian government can issue sovereign bonds in an international market like London or New York and such bonds can be denominated either in Dollars, Euro, GBP or any of the hard currencies. Such sovereign bonds are denominated in a foreign currency and they result in foreign currency flows into the RBI coffers. However, such sovereign bonds need to be serviced in foreign currency and that means these bonds are subject to currency risk. In a nutshell, if the dollar strengthens versus the rupee then the dollar liability will increase. The big concern for the government has been that the rupee depreciation could substantially increase the effective funding cost of the debt. That is the risk inherent in sovereign bonds.

Reason the PMO was too cautious about sovereign bonds

The concerns over sovereign bonds are on three fronts; and rightly so. Firstly, the currency risk illustrated above is a real problem for India. Since the inflation and interest rates are higher in India than in the US, a natural depreciation off the rupee versus the dollar is par for the course and that will add to the cost of such sovereign borrowings. Secondly, when a government issues sovereign bonds its own sovereign ratings get impacted. India has been working hard with rating agencies for a sovereign upgrade to “Investment Grade”. This would only delay the exercise. Lastly, global markets are in a state of flux. The trade war is almost impelling China to trigger a currency war. Such a currency war would not only weaken the rupee but also lead to risk-off flows in favour of the US Dollar and other hard currencies. That would be an added risk for sovereign bonds. It was in this light that the PMO became extremely cautious about the issue of sovereign bonds and decided to put it off to another day.

Fact is, now is the right time India can afford to issue sovereign bonds

There are also strong justifications to go ahead with the sovereign bonds at this point of time. Indian financials are much more stable than most other emerging markets. If you look at it logically, then there is a fit and proper case for India to issue these sovereign bonds. Here is why.

· India’s fiscal deficit is well within the 4% mark, even if you consider the off balance sheet liabilities in the nature of food subsidies and oil subsidies. That is reasonable if India can sustain annual growth above 7%.

· RBI has a forex reserve chest of $480 billion and barring in 2018, the FPI flows have been fairly robust into India. This should more or less compensate for any currency risk that the government would run.

· In 2019, RBI paid a record dividend of Rs.123,000 crore (apart from returning capital of Rs.53,000 crore) to the government. Any RBI dividend is effective monetization of deficit and can be inflationary. Comparatively, sovereign bonds would be a transparent way of bridging the funding gap.

Indian government has traditionally avoided sovereign bonds due to the inherent risks. With the comfortable forex situation and robust flows via FPI and FDI, the time is ripe to seriously consider sovereign bonds issue. This is something even countries with much smaller reserves are already doing and doing it successfully.