24/07/2019 - Indian Economy | GS III

IAS Parliament 5 years

KEY POINTS

· Indian government would start raising a part of its gross borrowing programme in external markets in external currencies.

· The issuer of a bond promises to pay back a fixed amount of money every year until the expiry of the term, at which point the issuer returns the principal amount to the buyer. When a government issues such a bond it is called a sovereign bond.

· Some of the best known sovereign bonds are the Treasuries (of the United States), the Gilts (of Britain).

· India’s sovereign bonds, that will be floated in foreign countries and will be denominated in foreign currencies, the initial loan amount and the final payment will be in either US dollars or some other comparable currency.

Sovereign bonds viable one

· Possibly the biggest of these is that the Indian government’s domestic borrowing is crowding out private investment and preventing the interest rates from falling even when inflation has cooled off and the RBI is cutting policy rates.

· If the government was to borrow some of its loans from outside India, there will be investable money left for private companies to borrow; not to mention that interest rates could start coming down.

· In fact, the significant decline in 10-year G-sec yields in the recent past is partially a reason.

· There is scope for the Indian government to raise funds this way without worrying too much about the possible negative effects.

· A sovereign bond issue will provide a yield curve — a benchmark — for Indian corporates who wish to raise loans in foreign markets. This will help Indian businesses that have increasingly looked towards foreign economies to borrow money.

Risks involved

· The volatility in India’s exchange rate is far more than the volatility in the yields of India’s G-secs (the yields are the interest rate that the government pays when it borrows domestically).

· This means that although the government would be borrowing at “cheaper” rates than domestically, the eventual rates (after incorporating the possible weakening of rupee against the dollar) might make the deal costlier.

· Borrowing outside would necessarily reduce the number of government bonds the domestic market will have to absorb. That’s because if fresh foreign currency comes into the economy, the RBI would have to “neutralise” it by sucking the exact amount out of the money supply.

· This, in turn, will require selling more bonds. If the RBI doesn’t do it then the excess money supply will create inflation and push up the interest rates, thus disincentivising private investments.

· Lastly, based on the unpleasant experience of other emerging economies, many argue that a small initial borrowing is the thin end of the wedge. It is quite likely that the government will be tempted to dip into the foreign markets for more loans every time it runs out of money.

· At some point, especially if India does not take care of its fiscal health, the foreign investors will pull the plug on fresh investments, creating dire consequences for India.