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Time ripe for sovereign external borrowing

Thanks to reasonable economic growth, benign inflation outlook, and a resilient external sector

The Union Finance Minister, Nirmala Sitharaman, in her maiden Budget speech on July 5 made a significant announcement in paragraph 103 that reads: “India’s sovereign external debt to GDP is among the lowest globally at less than 5 per cent. The Government would start raising a part of its gross borrowing programme in the external market in external currencies. This will also have a beneficial impact on the demand situation for government securities.”

The announcement has been criticised by some for the risks of such an issuance while the government is at pains to explain that it has considered all the risks before making the announcement.

A clarification issued by the government officials said it will raise around $10 billion first in September 2019. Amid the controversy, a few facts are in order.

Key parameters

First, the sovereign external borrowing will be a part of consolidated fund market borrowing for which the Budget has assumed a gross amount of ₹7,10,000 crore (taking into account the net market borrowing of ₹4,73,122 crore and repayments of ₹2,36,878 crore). The government figure of $10 billion thus takes into account the exchange rate ₹75 to a dollar.

Second, the sovereign’s debt as a percentage of GDP, as per the data released by RBI on June 28, stood at 3.8 per cent as against 4.3 per cent in 2018 and 4.5 percent in 2017. It may be mentioned that these figures pertain to the residual maturity of external debt and amounted to ₹103.5 crore in absolute terms accounting for about 19 per cent of total external debt.

Third, the current account deficit as percentage to GDP was 2.1 per cent in 2018-19, which was financed comfortably by capital flows (both debt and equity).

Fourth, since most of the external sector vulnerability indicators such as debt to GDP (19.7 per cent), debt to forex reserve (76 per cent), debt service ratio (6.4 per cent) and forex reserve to import cover (eight months) have been at a steady state and stabilised, there is some amount of resilience in the external sector.

Fourth, though economic growth has slowed down, it is highest in the global context and is accompanied by a benign inflation outlook.

Fifth, volatility of the rupee is least among the emerging market economies. Sixth, India has got the investment grade rating (Baa2) from Moody’s.

Seventh, even though the fiscal deficit (5.8 per cent of GDP) and debt (68 per cent of GDP) is at a higher level for the general government (both Centre and the States), the strong commitment voiced by the government for fiscal consolidation will be well received by the global market.

In view of the foregoing, this is an opportune time for the government to float sovereign external borrowings. There are of course associated risks with sovereign external borrowings as country experiences tell us.

The most important is the default risk, but taking into account the robust forex reserves of around $428 billion as on June 28, 2019, global investors will draw enough confidence to invest.

Debt manager

Having said this, the modalities of issuance covering various aspects — management of issuance, countries, stock exchanges, coupon rate, and maturity — are crucial and need to be looked at immediately. According to the RBI Act, 1934, the RBI is the debt manager for issuance of government debt. The sovereign debt issuance will also be conducted by the RBI, which will have to appoint a global manger to undertake this.

The global manger will be an investment banker of high repute and the selection of the global manger will be done through the bidding process (may be the lowest commission bidder will be selected). The amount of commission globally at the upper-end has been 1 per cent of the issuance size.

It is appropriate to float the issuance in countries where there is a large presence of NRIs like North America, and the Middle East. In addition, Japan is a good place to float this because of the strong political association and past bilateral swap arrangements between Japan and India. The currency of the bond will be in US dollar and Japanese yen. The external sovereign bonds will be listed in three important stock exchanges: London, New York and Tokyo. Listing will help and facilitate secondary market trading.

The crucial issue is the coupon rate and maturity. There are a few options. One is regular vanilla bonds with a prefixed coupon rate. The second is zero coupon bonds and the third is inflation index bonds. However, to begin with, regular vanilla bonds are preferred, being more investor-friendly. The decision on the interest rate is crucial.

As per the data available in the Status Report of external debt, the implicit interest rate for external debt was 1.3 per cent for concessional rate, 4.4 per cent for NRI deposits and 4.7 per cent for External Commercial Borrowings. The fixation of interest rate has to be seen both from the issuer and investor point of view.

A 10-year bond for domestic government debt was 7.34 per cent in 2018-19. In the US, a 10-year bond yields around 2 per cent, and in Japan it is (-) 0.15 per cent. Taking into account these factors, a suggested coupon rate is 3-4 per cent with no currency, interest rate and credit risk for the investor. As an issuer, the government will get the benefit of diversification of investor bases with global presence, and there could be some easing of pressure on the domestic bond rates.

With reasonable economic growth, benign inflation outlook, a resilient external sector and, above all, political stability, it is an opportune time for the authorities to enter the global market with sovereign bond borrowing. The critical issue here is the appointment of an investment banker as a global debt manager.

Testing the market with a new approach to raise sovereign external debt is one thing, but falling into a trap by repeated floating of bonds and unwarranted enthusiasm is quite another. In this, while the approach is good, the watchword should be caution.

The writer, a former central banker, is a faculty member at SPJIMR. The views are personal. (Through The Billion Press)

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