Explore sovereign debt, but with care

The thrust of the Economic Survey 2018-19, ‘Shifting gears to private investment as the key driver of growth’, though relevant, appears rather dated. In the nearly three decades of reforms in India, private capital has been given enough push.

Since opening up to foreign capital in the early 1990s, India received FDI to the tune of $500 billion till 2018; this may look rather tame against China’s $2 trillion. Another $237 billion came from FPIs (foreign portfolio investors). New equity and debt capital issuance too surged.

The share of the private sector in bank assets and insurance grew up to 30 per cent of the respective segments, and accounted for most of the mutual funds. ECBs, corporate bonds, NRI deposits, and trade credit added another $647 billion. Foreign investments in venture capital and portfolios, among others, keep widening through various instruments. With 900 FIIs, 49 foreign banks and numerous NBFCs operating from India, finance has a fairly large universe of domestic and foreign private players.

Incidentally and perhaps ironically, much of the problems that India now confronts emanate are from private capital. The failure of IL&FS and its contagion effect on NBFCs, fund management and corporate credit have added to the anguish. The private capital argument, thus, is more about India making the next move towards the sovereign bonds market, stirring up a debate on its time, relevance and requirement.

The timing: It’s an opportune time for India to explore sovereign bonds. The US monetary policy, which had been hawkish till recently, has turned dovish. Yield on the 10-year Treasury bond turned lower than that of three-month government debt.

Markets are now expecting sequential cuts in interest rates rather than a calendar of hikes from the Federal Reserve. This should augur well for EMs (emerging markets) in general and India in particular.

The opportunity. Yield difference between emerging market and developed market debt, which is about two percentage points, is a big incentive for international investors. Bigger EMs hold better prospects. Saudi Arabia had not issued any sovereign debt between 2007 and 2015 but in the last three years sold $70 billion in international debt, the most recent being an Euro issue of $3.37 billion which was oversubscribed five times at an attractive yield. India has its own allure, as the fastest growing and third largest economy (PPP) in the world, with a strong and stable government that is keen to take the economy to $5 trillion.

The growing club. EM debt is huge and growing. At about $15 trillion, it comprises government and corporate bonds issued in local and hard currencies and their respective futures swaps and credit. The JP Morgan Emerging Market Bond Index tracks 67 EM bond markets. EM high-yield bonds now account anywhere up to 23 per cent of global high yield investment opportunities compared with just 8 per cent in 2009.

The share of Asia in EM corporate bond stock has risen from 33 per cent in 2011 to 51 per cent in 2018. Sovereign bond issuance too has been growing, from $7 trillion in 2007 to an estimated $11 trillion in 2019 in OECD countries, and from $450 billion in 2010 to $1 trillion in 2018 in EMs.

The advantage: Though EM debt suffered reversals in 2018, markets expect this year to be a banner year. Though growth is thawing, fundamentals remain strong, yield spread is expanding, valuations are becoming attractive, and the rating gap between high yield EM and US corporates is narrowing.

On the external front, the incentives to look at India include the external debt/GDP ratio, which has fallen from 24 per cent in 2014 to 19.7 per cent in 2018.

The challenge: Surely sovereign debt has not been such a smooth ride for many. Those mired in debt restructuring suffered enormously with shrinkage in the economy and loss of growth. The peculiarities that make sovereign debt different from other types of debt are: it cannot use a bankruptcy code like a corporate or an individual, usually exposed to hostile creditor actions; and difficulty in enforcement of arbitration or court decision. However, enough experience has been gained globally on its management that would surely be handy for India to make it work.

The prospect: As a major economy in the world, India could move up in the value chain the way China did, by developing its local currency debt market as a platform for other countries to raise money. Poland, Hungary, the Philippines, the Emirate of Sharjah, British Columbia and South Korea raised Panda Bonds in China to the extent $2.3 billion with Bank of China as the lead underwriter.

China had also used its two Special Administrative Regions to raise sovereign bonds first in Hong Kong ($2 billion) in 2017 and in Macau ($290 million) early this month.

The priority: Not to lose sight is the importance of public capital. According to Asia Infrastructure and Investment Bank (AIIB), demand for infrastructure in Asia alone is about $26 trillion, with annual supply of $1 trillion and a financing gap of $0.7 trillion. A major part of the financing, of up to 70 per cent, is expected to come from government sources, 20 per cent from the private sector, and 10 per cent from multilateral development banks.

Potential sources from the private sector are the institutional investors whose fund management size is reaching anywhere up to $106 trillion by 2030. Recent surveys showed the growing interest of institutional investors in infrastructure and emerging markets, though a few operational issues remain to be sorted out. Domestic development banking could be a great enabler in this regard.

While pursuing private capital, the imperatives of public capital cannot be overlooked. Amidst concerns of a slowdown, growing trade war with the US, and rising resistance to its technologies (Huawei), China is deploying the power of its public capital to soften the borrowing costs, by bringing it to the lowest levels since April 2009 — the Shanghai Interbank Overnight Benchmark Rate fell to 0.884 per cent a few days ago.

That is the power and potency of public capital which every emerging market should be sufficiently endowed with, to sail through the choppy waters of global private capital.

The writer runs the consulting firm ‘Growth Markets Advisory Services’. The views are personal