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It is interesting how committed globalizers suddenly turn near-nationalist when it comes to sovereign borrowings in non-rupee debt. The Union budget presented by Nirmala Sitharaman indicated that India would be raising a sovereign debt issue this year to benefit from lower global rates, but barely did she make the announcement that most former Reserve Bank of India (RBI) governors, from C. Rangarajan to Raghuram Rajan, have come out strongly against the idea.
Rajan, in a well-argued piece in The Times Of India, offers several arguments against sovereign dollar borrowings. Some of them are valid, but the overall tenor seems like too much scare-mongering over an issue that is small in the context of the country’s overall foreign exchange reserves.
Rajan makes the following arguments against sovereign borrowings in dollars. First, he rubbishes Sitharaman’s claim that India’s overall low sovereign external debt position is a good enough reason to borrow more abroad. Second, if the idea was to fund domestic borrowings from foreign sources, this can be done as easily by raising the limit on foreign investments in government rupee bonds. And it is not as if sovereign dollar bonds will reduce the issue of rupee bonds. This may have to be done by the RBI selling its own bond holdings to sterilize the dollar inflows involved.
The stronger arguments offered include the following: One is that while dollar borrowings are cheaper in terms of interest costs, these could be offset by higher principal payments if the rupee falls against the dollar at the time of redemption. And while a sovereign bond will expand the set of investors who buy in Indian debt, Rajan suggests that this may only bring in “faddish" investors who buy when India is “hot" and flee when it is not.
If one looks closely at each of Rajan’s counter-arguments, the real one is this: What if the government borrows today in dollars and, at the time of repayment, has to fork out more since the rupee may have depreciated, as has been the norm so far? Implied in this is that rupee debt is always more manageable even if the outstanding sums go out of whack.
We need to question the latter assumption first. Underlying it is the logic that if inflation somehow rises, the nominal value of the debt remains the same, and so the government will be paying back in depreciating rupees. This argument boils down to something more worrying: It is okay to cheat domestic investors by letting inflation take care of repayments, but foreign investors will not take this lying down.
The rest of the arguments are neither here nor there. “Hot" money is even now flowing in and out of stocks and bonds. RBI data shows that nearly $260 billion of portfolio money is invested in stocks and debt, as of March 2019, and if this money decides to flee, it can rock the forex markets.
This brings us to the core of Rajan’s argument against a sovereign bond issue: the possibility that you may have to pay more if the rupee depreciates.
There are two counters to this. First, hasn’t borrowing in dollar-denominated debt, with the government taking on exchange rate risks, always been our No. 1 remedy for any tight situation? In 1991, Manmohan Singh’s pro-reform budget provided exchange rate cover for an issue of dollar-denominated Indian Development Bonds. In 1998, the National Democratic Alliance (NDA) government offered Resurgent India Bonds with similar currency protection. In 2000, this was followed by the India Millennium Deposit scheme, once more with government taking the exchange rate risk. As soon as Rajan took over as RBI governor in 2013, banks were encouraged to raise dollar deposits at a subsidized forward cover rate of 3.5%, nearly half the normal cost of hedging in the market.
Put simply, the sovereign and the central bank have always taken on the exchange rate risks involved in raising dollars over nearly three decades since 1991, and the fact that this time it is the sovereign itself raising the debt is hardly going to worsen the risks related to adverse exchange rate movements.
Second, it is not a given that the rupee will keep depreciating. On the contrary, if the government goes the whole hog to increase foreign direct investment in several new areas, as the budget has proposed, and our relative inflation rate compared to the US and Europe remains just 1.5-2.5% above theirs, the rupee may not depreciate that much. It could even appreciate if dollar inflows expand substantially over the coming years. Given that China is now less attractive as a destination and high-return investment opportunities in Europe, the US and Japan are limited, is it logical to assume that foreign direct investment will not boom in India in a world awash with capital?
This writer is neutral to the idea of sovereign borrowings denominated in dollars, but surely it cannot be overly risky to borrow, say, $20-40 billion over the next few years, when there is little risk of dollars fleeing the country in panic and foreign exchange reserves stand at a healthy $425 billion plus. In these circumstances, crying wolf over a sovereign dollar bond issue seems a trifle premature. The time to worry about it will be after four or five years, when we know how the rupee will behave.
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Rajan, in a well-argued piece in The Times Of India, offers several arguments against sovereign dollar borrowings. Some of them are valid, but the overall tenor seems like too much scare-mongering over an issue that is small in the context of the country’s overall foreign exchange reserves.
Rajan makes the following arguments against sovereign borrowings in dollars. First, he rubbishes Sitharaman’s claim that India’s overall low sovereign external debt position is a good enough reason to borrow more abroad. Second, if the idea was to fund domestic borrowings from foreign sources, this can be done as easily by raising the limit on foreign investments in government rupee bonds. And it is not as if sovereign dollar bonds will reduce the issue of rupee bonds. This may have to be done by the RBI selling its own bond holdings to sterilize the dollar inflows involved.
The stronger arguments offered include the following: One is that while dollar borrowings are cheaper in terms of interest costs, these could be offset by higher principal payments if the rupee falls against the dollar at the time of redemption. And while a sovereign bond will expand the set of investors who buy in Indian debt, Rajan suggests that this may only bring in “faddish" investors who buy when India is “hot" and flee when it is not.
If one looks closely at each of Rajan’s counter-arguments, the real one is this: What if the government borrows today in dollars and, at the time of repayment, has to fork out more since the rupee may have depreciated, as has been the norm so far? Implied in this is that rupee debt is always more manageable even if the outstanding sums go out of whack.
We need to question the latter assumption first. Underlying it is the logic that if inflation somehow rises, the nominal value of the debt remains the same, and so the government will be paying back in depreciating rupees. This argument boils down to something more worrying: It is okay to cheat domestic investors by letting inflation take care of repayments, but foreign investors will not take this lying down.
The rest of the arguments are neither here nor there. “Hot" money is even now flowing in and out of stocks and bonds. RBI data shows that nearly $260 billion of portfolio money is invested in stocks and debt, as of March 2019, and if this money decides to flee, it can rock the forex markets.
This brings us to the core of Rajan’s argument against a sovereign bond issue: the possibility that you may have to pay more if the rupee depreciates.
There are two counters to this. First, hasn’t borrowing in dollar-denominated debt, with the government taking on exchange rate risks, always been our No. 1 remedy for any tight situation? In 1991, Manmohan Singh’s pro-reform budget provided exchange rate cover for an issue of dollar-denominated Indian Development Bonds. In 1998, the National Democratic Alliance (NDA) government offered Resurgent India Bonds with similar currency protection. In 2000, this was followed by the India Millennium Deposit scheme, once more with government taking the exchange rate risk. As soon as Rajan took over as RBI governor in 2013, banks were encouraged to raise dollar deposits at a subsidized forward cover rate of 3.5%, nearly half the normal cost of hedging in the market.
Put simply, the sovereign and the central bank have always taken on the exchange rate risks involved in raising dollars over nearly three decades since 1991, and the fact that this time it is the sovereign itself raising the debt is hardly going to worsen the risks related to adverse exchange rate movements.
Second, it is not a given that the rupee will keep depreciating. On the contrary, if the government goes the whole hog to increase foreign direct investment in several new areas, as the budget has proposed, and our relative inflation rate compared to the US and Europe remains just 1.5-2.5% above theirs, the rupee may not depreciate that much. It could even appreciate if dollar inflows expand substantially over the coming years. Given that China is now less attractive as a destination and high-return investment opportunities in Europe, the US and Japan are limited, is it logical to assume that foreign direct investment will not boom in India in a world awash with capital?
This writer is neutral to the idea of sovereign borrowings denominated in dollars, but surely it cannot be overly risky to borrow, say, $20-40 billion over the next few years, when there is little risk of dollars fleeing the country in panic and foreign exchange reserves stand at a healthy $425 billion plus. In these circumstances, crying wolf over a sovereign dollar bond issue seems a trifle premature. The time to worry about it will be after four or five years, when we know how the rupee will behave.
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