In a report on the Government’s proposed foreign currency (FCY) sovereign bond issuance, Kotak Securities stated that it will warrant greater macroeconomic prudence in light of high extent of foreign ownership in Indian debt and equity.
Kotak Securities also mentioned that while attracting foreign savings into debt is essential, it should not be based on a short-term view of current low interest rates while internalising foreign exchange (FX) risks.
"We are not sure of the requirement for FCY sovereign bonds at the current juncture. We believe thatbetter fiscal management and focus on economic reforms will result in higher domestic savings, which will obviate the need for FCY sovereign debt," said authors Suvodeep Rakshit, Upasna Bhardwaj and Avijit Puri.
The authors assessed that in the long run, payouts on FCY borrowing will be similar (if not higher) to LCY (local currency) sovereign issuances — with conservative FX assumptions.
They cautioned that current benign global financial conditions will definitely not sustain in the long term. Expanding the FCY sovereign liabilities could magnify the macro risks if essential reforms on improving public finances and local debt markets’ deepening remain inadequate.
While the initial issuance could be attractive given the macro-fundamentals, the report noted that FCY ratings and rates (spreads over currency of issuance) are closely linked. Recently, economies rated similar to India have issued 10-year US Dollar bonds at an average spread of 120-150 basis points over 10-year United States (US) T-Bill.
India has a high dependency on foreign equity capital: $433 billion in foreign portfolio investor (FPI) equity (46.1 per cent of the free-float market capitalisation of BSE-200) and $325 billion in foreign direct investment (FDI) equity (cumulative net inflows from FY2000 excluding valuation effects). In comparison, foreign debt of $309 billion in Indian companies and $104 billion for the government seem low.
Prudent fiscal management
"We firmly believe that India may want to look at a more prudent fiscal management as it begins issuance of FCY sovereign bonds," the report said.
Historical experiences of countries with high exposure to foreign capital and weak macro fundamentals such as Argentina, Thailand, Brazil, Turkey, etc have not been pleasant, it added.
The authors suggested that the Government can aim for: (1) statutory limits on both incremental and outstanding FCY sovereign issuances based on domestic and external vulnerability metrics, (2) long-term FCY borrowings (in multiple currencies to take benefit of relatively more accommodative monetary policies ) and a staggered hedging strategy, and (3) outlining a more transparent fiscal accounting framework (including sovereign and quasi-sovereign entities).
The reliance on FCY issuances should be kept at a minimum with the explicit aim of diversifying the market presence rather than substituting domestic borrowing (along with a strict check on fiscal profligacy).
RBI intervention in FX market
The report observed that policy-makers will need to carefully assess the effects of the FCY bond issuances. As a base case the authors believe that the RBI will need to intervene pro-actively in the FX market and engage in liquidity management to avoid possible disruptions.
"The INR (Indian Rupee) liquidity infusion due to the intervention may require RBI to recalibrate its liquidity actions depending on the reserve money demand (either through lower OMO -- open market operation -- purchases or through OMO sales). While this may halt (or reverse) the current bond rally, expectations of lower supply could cap the upside risks," explained the authors.
Meanwhile, other parameters such as INR and forward premia could largely remain unchanged (unless government immediately hedges) while BOP (balance of payments) and FX reserves would increase.
The report said higher FX reserves would improve the ability of the Reserve Bank of India (RBI) to tackle volatility in the FX market. This scenario if coupled with the government engaging in opportunistic hedging at times of INR appreciation would allow room for sharing the responsibility of managing currency volatility with RBI.