All you wanted to know about... Foreign sovereign bonds

| Updated on July 22, 2019 Published on July 22, 2019

There has been a lot of noise around foreign sovereign bonds ever since the Finance Minister Nirmala Sitharaman proposed to raise part of the Indian government’s borrowings in the external markets in other currencies. While there has been heated debate among economists on the pros and cons of such a move, the bond markets appear to be pleased.

What is it?

Let us first understand what sovereign bonds are. Essentially, they are government securities issued in order to finance the fiscal deficit and manage the temporary cash mismatches of the government. There is always a ready market for government securities. Apart from a fixed return, they offer the maximum safety, and are also actively traded in the secondary market. Now, central government securities can be denominated in either foreign or domestic currency. In India, the government has only issued sovereign bonds in local currency in the domestic market. Foreign portfolio investors have evinced interest in Indian government bonds traded locally in recent years., as the real interest rate on Indian bonds is attractive compared to other developed countries. But currency stability is vital for such investors, as they take the currency risk investing in rupee-denominated government bonds.

This is where a foreign sovereign bond makes a big difference. A government bond issued in foreign currency (mostly in US dollars) shifts the currency risk from investor to issuer (in this case, the government). Such bonds can be settled on Euroclear, the world’s largest securities settlements system, simplifying ease of investing for foreign investors.

Why is it important?

The issue of international sovereign bonds will have several long-term implications. It may facilitate the inclusion of India’s government bonds in the global debt indices. India’s representation in global debt market indices is small compared to other emerging markets. This may lead to higher foreign inflows into India.

Two, inclusion in global benchmarks would also improve the attractiveness of rupee-denominated sovereign bonds. Three, the rates at which the government borrows overseas will act as a yardstick for pricing of other corporate bonds, helping India Inc raise money overseas. While some commentators think that the government can borrow at very low costs overseas, this argument is weak, as it will have to hedge against forex risks.

But despite so many benefits, why has there been no issue of such bonds so far? That’s because there are risks too. Dollar-denominated bonds are more sensitive to global interest rates. Global shocks, as seen in the 2013 taper tantrums, can lead to heightened selling pressure on Indian bonds. For now, foreign investors’ holdings in Indian debt has been low, at about 3.6 per cent of outstanding government securities. In the Indonesian bond market, it is 38 per cent, while in Malaysia it is about 24 per cent. The RBI has been taking baby steps in opening up the limits for foreign investors, to ensure that we are not as vulnerable to an exodus of funds. So if the government does issue foreign sovereign bonds, it must exercise caution.

Why should I care?

How does all this impact you? For one, such a move can lower yields on government bonds in the domestic market. For the current fiscal, the Centre’s gross market borrowings are at ₹7.1 lakh crore. Raising part of this overseas can ease oversupply of government bonds in the domestic market. Since interest rates on financial products track the movement in G-Sec yields, this can reduce interest rates on loans and savings.

Interest rates offered on post office savings or bank fixed deposit rates can move lower, if the yields on government bonds fall. Banks can also lower their lending rates. Remember though, the increased vulnerability of Indian bond markets to foreign flows can pinch you too, with more volatile returns from debt funds.

The bottomline

Bonding overseas can be good, but with caveats.

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Published on July 22, 2019
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