Borrow abroad, but with caution

The Finance Minister’s proposal to raise part of the government’s borrowings in external markets and in external currencies, has pleased the bond market and found favour with several economists. Given that the Centre’s gross market borrowings for the current fiscal are pegged at a high ₹7.1 lakh crore, the move to raise part of this overseas can ease the risk of oversupply of government bonds in the domestic market. Large government borrowings lead to crowding out of the private sector and add pressure on domestic rates and liquidity. Consequent hardening of yields can have a cascading effect on interest rates in other segments of the financial market. In times of monetary easing, this can be counterproductive, and hinder transmission of rate cuts by the RBI.

But short-term gains aside, issuance of international sovereign bonds — which will facilitate inclusion into global bond indices — is also imperative if we wish to draw greater foreign inflows into the Indian debt market. Currently India’s representation in global debt market indices is relatively small compared to other emerging markets. The IMF’s latest global financial stability report had stated that the renminbi-denominated government and policy bank bonds added to the Bloomberg Barclays Global Aggregate Bond Index starting in April 2019 and phased in over a 20-month period, could bring $150 billion in additional inflows to China by 2020; other emerging markets may consequently see a reduction in flows. Given that a lack of liquidity and effective benchmarks have kept foreign investor interest tepid in India’s corporate bond market, sovereign issuances can also open floodgates of liquidity for Corporate India. Also, foreign investors’ holdings in Indian debt thus far have been low, offering ample leeway. FPIs currently constitute about 3.6 per cent of government securities’ holdings. In the Indonesian bond market it is a whopping 38 per cent, while that in Malaysia is about 24 per cent. These countries are also more vulnerable to an exodus of funds from their bond markets.

But this is where India will have to tread cautiously. So far, the RBI has been slowly increasing the cap on foreign institutional investments in the G-Secs market. Continued prudence in restraining short-term borrowings will be imperative. Global shocks can lead to heightened selling pressure on emerging market bonds. Also, a sound financial market infrastructure — clearing, payment and settlement systems and custodian services among others — is a prerequisite for foreign investor access. Above all, the lower borrowing cost argument should not prompt a reckless attempt by the Centre. Even though there is a notable interest rate differential in borrowing overseas (more than 3-odd per cent in dollar terms), hedging cost of reportedly 4-odd per cent would imply a similar cost in rupee terms. To mitigate volatility risk, broadening the investor base to include, apart from banks, other domestic institutions like insurance companies and pension funds is also important, as they can step in to offset some of the pressures in times of heightened capital outflows. These structural aspects need to be dealt with before taking up the Finance Minister’s proposal.

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