You need to first know that exactly is a sovereign bond. It is debt issued by the central government of a country in a foreign market denominated in foreign currency like the dollar, euro or pound. Such sovereign bonds are denominated in a foreign currency and they result in foreign currency flows into the RBI coffers. However, there is a risk in that such sovereign bonds have to be serviced in foreign currency and that means these bonds are subject to currency risk. The risk is that if dollar strengthens versus the rupee then the dollar liability will increase. That is explained in the table.

Sovereign Borrowings

Amount

Sovereign Repayment

Amount

Indian Gov borrows

$1 billion

Redemption Value (4% compounded per year)

$1.217 billion

Interest cost (compound)

4.00%

Currency after 5 years

Rs.78/$

Tenure

5 Years

Indian rupee equivalent

Rs.9,493 crore

Interest payable on

Redemption

Effective Cost paid out

7.87%

Exchange Rate

Rs.65/$

Rupee value on Issue

Rs.6,500 crore

This is the risk that the PMO has been worrying about and has also highlighted to the finance minister. The government is not too keen to take on currency risk off that order as it would lead to lowering of India ratings. That is the reason the issue has been put off to next year till the time global economy stabilizes.

Should India take on the risk of sovereign bonds at this point of time?

If you look at it differently, we are talking about a sovereign bond issue of around $10 billion, which is not too big considering the size of the Indian economy. India can afford to take on this risk at this point of time for the following reasons.

· India’s fiscal deficit has been within 4% of GDP. Even if you add up the off balance sheet liabilities in the nature of food subsidies and oil subsidies, it is still below 5%. That is not a major risk if India can sustain annual growth above 7%.

· Look at our forex reserves today. RBI has a forex reserve chest of $430 billion and barring the last one year, the FPI flows have been fairly robust into India. This should more or less compensate for any currency risk.

· RBI has paid a record dividend of Rs.123,000 crore to the government as dividends. Any RBI nothing but monetization of deficit and can be inflationary. Comparatively, sovereign bonds would be a transparent way of bridging the funding gap.

To answer the second part of your question, the comfortable forex situation and robust flows via FPI and FDI, offer an opportunity to consider sovereign bonds seriously.