We have sufficient forex reserves to see us through the next six months of import bill payment but that is no insurance against foreign exchange risk.
The budget announcement of issuing foreign currency- denominated sovereign bonds has attracted disproportionately high interest among economists and market participants alike. This interest is mainly because this is the first time that such issuance is being attempted.
There is certainly a foreign exchange risk involved, however, this is only one part of the whole issue. We have sufficient forex reserves to see us through the next six months of import bill payments but that is no insurance against a foreign exchange risk.
Where do resources come from?
It is a well-known fact that it is almost impossible to depend only on domestic resources to fund the developmental needs of the country. Where are the resources going to come from? Governments, both central and state, together would take away close to Rs 10 lakh crore from the market this year itself, through market borrowing programmes. This will, to a large extent, deprive the private sector of its fair share of resources. Therefore, it is imperative that we depend on resources from abroad and it is an unavoidable factor, given the extra-ordinary developmental requirements of a large nation.
Bridging the resource gap
There are many ways in which this gap in resources can be met, primarily through trade and investments. That is either by expanding the footprints in trade, or by attracting investments into the country which are of a long-term nature. Investments may be FII or FDI investments, and FII investments have a component of hot money flows too. While India has been dependent on both, China’s calculated reliance on FDIs is quite remarkable, as this has served it well in the last two decades when it needed it the most. We have not made any differentiated effort in promoting one over the other. While our trade remains an insignificant portion of the global trade, as of now the only silver lining is investments.
Apart from FIIs and FDIs, inviting overseas investors to look at our sovereign debt remains one of the potent possibilities. However, this requires quite a bit of groundwork before we actually get into it. It is not the forex risk that is important in this context but the need to put in place a framework or apparatus which could help such issues to sail through smoothly, and also trade and settle comfortably, and thereby, instilling confidence in investors and sustain their interest and investments.
Inclusion in foreign bond indexes
One of the reasonable pre-requisites for a smooth sailing of a foreign currency sovereign bond issue is the inclusion of gilts in some of the prominent bond indexes available globally.
One of the indexes is the JP Morgan Emerging Markets Bond Index. It is reported that close to US$ 250 billion is invested as per this index. Many emerging market bonds are part of this index, but gilts (India domestic sovereign bonds) are not. If we include gilts in such indexes, funds from around the world will automatically invest into gilts in the proportion in which gilts are part of those respective indexes. But such inclusion would entail certain responsibilities we need to commit upfront and implement in a time-bound manner.
Taking convertibility to the next level
Most of this pertains to capital account convertibility, as that alone will facilitate free conversion of the rupee into other currencies and vice versa, at market rates, and it forms the basis for an active market for gilts in international markets.
Investors in rupee-denominated instruments need to hedge either by selling the Indian currency in forwards or through currency derivatives and this is not fully possible under the current regime of exchange rate management. If not a full convertibility, a substantial move in that direction is required to enhance the participation of overseas investors in the gilts market.
International listing, trading and clearing
While international investors participate in markets, they particularly look at the tradability and liquidity of instruments. The size of the issues in the benchmarks should increase manifold, and there should also be listing of gilts at all major international stock exchanges, and this alone will facilitate access to trading and liquidity in gilts across time zones.
All major sovereign bonds are traded across time zones and one can get prices at any point of time. There needs to be arrangements and tie-ups with international clearing corporations, say, like Euro clear, Clear stream, for transaction settlement and clearing in gilts or rupee bonds.
Japan is a classic example of how JGBs and Euro-Yen bonds are traded across time zones and with listing at all major stock exchanges. These highly liquid instruments form part of the portfolios of major international investors from trusts and family offices to central banks and financial institutions.
There is no alternative to listing on major stock exchanges. It is important to note that instead of foreign-currency bonds, rupee-denominated bonds can also be issued and listed abroad. This would redefine forex risk for the issuer as well as the investors. Euro-Yen bonds are a living example of such successful issues.
A public debt office and role of primary dealers
There are a couple of institutional reforms that are required to further this cause.
The first is the setting up of a public debt office of the government of India to handle issue and the management of debt, a function currently handled by the RBI.
The RBI with its independent responsibilities in the administration of monetary policy may not be a suitable agent for debt management. This has been already acknowledged by both the RBI and the government but the reforms have not been initiated as yet. Such an agency will be able to handle the task of the foreign currency sovereign debt issue as well.
Second, it is imperative that the system of primary dealership be strengthened to facilitate major overseas entities bidding through them and for them to build capabilities to absorb incessant selling as it happens once in a while. Even in this aspect Japan holds some lessons for us. They act together.
The inevitable foray
A one- off kind of a small issue may be alright as an experiment, but the government should put in place an entire mechanism for issue of such bonds on a regular basis, which includes listing as well as safe custody, trading and servicing.
It is important that investors should get used to it and draw comfort from the fact that the apparatus provides the system the necessary support, as and when required.
The issue of sovereign bonds is inevitable, and it is a reality we should carefully walk into. It is not the forex risk that is important here but it is actually all the other aspects that are required to make the system work smoothly.
As billions of dollars are invested and many more billions are sold year after year, the issue of forex risk would become secondary or superfluous. This foray will have a significant impact on the way we manage our economy and also enhance the efficiency of economic and currency management.