Time for sovereign borrowing?
The conventional wisdom in India today frowns upon the idea of sovereign debt issuance; the idea of the Government of India selling bonds outside India, as opposed to only selling bonds inside India. In this article, I argue that this position should be questioned.
At the level of principle, there are two difficulties with a sovereign borrowing program. The first is a fear of linking up the supposedly well-run external sector with the badly-run finances of the government. It is felt that large-scale sovereign borrowing will provide a direct channel for internal mismanagement to generate an external crisis. The second concern is based on perverse incentives in exchange rate `management'. It is felt that if the Government of India has large dollar-denominated debts, and if the Government of India is the dominant player which can and does engage in market manipulation on the foreign exchange market, then there will be strong incentives for the manipulators to overprice the rupee so as to ease bond repayment.
There is much merit in these arguments. It is fair to observe that both are predicated on a scenario with "large-scale" sovereign bond issuance by the Government of India. Hence, one clear remedy which can be suggested is to have a limited scale of sovereign debt issuance.
More importantly, it is useful to observe that we are already engaging in sovereign borrowing, in effect. We have seen fund raising of $1.6 billion using the ``India Development Bond'' in 1991, of $4.2 billion using the ``Resurgent India Bond'' in 1998 and $5.3 billion using the ``Millennium India Deposit'' in 2000. There is every reason to expect that there will be more such products done in the future. Each of these products has a fig leaf attempting to disguise the truth, which is that this is Indian sovereign debt issuance.
With this style of fund-raising in hand, all the fears that economists have about sovereign debt issuance are already upon us. The relevant debate today is about comparing a format like IDB, RIB and IMD versus a sensibly design program for sovereign debt issuance.
What would a program for sovereign debt issuance look like? It would consist of issuing a set of zero-coupon bonds with maturities such as 0.25, 0.5, 1, 2, 5 and 10 years. These bonds, put together, would generate an Indian sovereign yield curve that is traded on the world market. The government should continually calibrate the issue size to ensure that each of these bonds are highly liquid by world standards; my guess is that an issue size of $0.5 billion each would do the trick. By issuing zero--coupon bonds instead of coupon--bearing bonds, we would reduce the extent of confused information processing by practitioners who do not understand fixed income analytics.
In summary, a sovereign bond issuance program which sold $3 billion of Indian bonds to the global market is likely to give us a liquid Indian yield curve. Such a program would immediately generate three benefits:
- Products such as IMD have had a silly preference in favour of selling to NRIs. There is no rational argument why India's taxpayers should support giving a good deal to the Indians who left. Bonds will trade at lower prices since they would innately have no such restriction.
- The intermediation costs of an entity like SBI would be eliminated by having a sovereign debt program which directly deals with global institutional investors. The cost to the Indian state of directly issuing sovereign bonds would almost certainly yield financing at a lower price than that seen with the IMD.
- Once these six bonds are actively traded on the world market, we would get daily data for the Indian yield curve, and the world's perception of Indian credit risk. These are valuable facts which are not publicly visible today. They would improve the ability of Indian firms to sell shares and bonds worldwide. It would become possible for entities such as Enron (which needs solvency on the part of the Indian State) to buy derivatives which pay when India's credit spread widens beyond a point, which would assist FDI.
Most economists see a new source of low-cost funding as fueling fiscal irresponsibility on the part of the Indian State. It is felt that the grand experiment, which began with the elimination of monetisation of the deficit in 1993, is only now starting to show some results in the form of fiscal prudence and a willingness to tax on the part of politicians. However, the risk of fiscal imprudence is already there with IDB, RIB and IMD. If India pre--commits to having a sovereign bond program which is (say) below 10% of India's external debt, then it eliminates this moral hazard.
When an Indian yield curve is traded outside India, it will provide daily data on the world's view of Indian credit risk. This will be a valuable "continuous evaluation" of Indian macro policies. Imagine the front page of this newspaper screaming India's credit spread rises above Pakistan's; this would be a new source of pressure in favour of sound macro policies.
My last argument is concerned with credit ratings. Today, global financial markets observe credit ratings for India. These credit ratings are widely mistrusted: for example, the rating agencies fully missed the East Asian Crisis, and the rating agencies broadly think that India was as vulnerable at the end of the 1990s as it was at the start of the 1990s. This is in contrast with global financial markets, which generally trade Indian paper at prices that are too high when compared with the ratings.
Poor information processing by the rating agencies is a vulnerability for India, when we look forward. India does seem to be lurching towards a next macro crisis, and it would help to build the tools which would help in dealing with it. In the environment of a crisis, it is simply imprudent to trust in the decisions made by a few individuals working in credit rating agencies (recall the downgrading of Korea). It is, hence, important for us to disintermediate the credit rating agencies by having a liquid Indian sovereign yield curve. A liquid market always knows more than any rating agency, so once an Indian yield curve is liquid, the global financial markets will respect it's credit spread more than they respect the rating agencies. This will reduce India's vulnerability to the rating agencies.
In summary, it would make sense for the government to now break with the fiction of not doing sovereign debt issuance, of breaking with the patterns of IDB / RIB / IMD, and get started on a proper sovereign debt issuance program. This would yield much cheaper funding when compared with IMD, and it would have an important informational externality in the form of a liquid Indian yield curve.
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