An abrupt reshuffle at the top of India’s finance bureaucracy makes it unlikely that the country’s inaugural issue of a controversial sovereign bond overseas will happen now. It’s just as well.
Borrowing in a foreign currency, possibly dollars, would have set back New Delhi’s attempt to drum up more global interest in rupee debt. An unexpected meeting of minds formed between Prime Minister Narendra Modi’s core Hindu nationalist supporters and his more internationalist critics to put the bond’s future in question.
Finance Secretary Subhash Chandra Garg was presumably the author – and is now the fall guy – of the foreign-debt adventure. In an unusual move for a senior Indian civil servant, he requested retirement after he was marched off to the power ministry. That’s enough for investors to speculate that the government wants to back off – as indeed it should.
Now that $10 billion in subscription checks won’t be coming in October, the domestic Indian bond market will feel the pressure of higher borrowings locally by the government. There’s a way to ease it, though: masala bonds, or rupee debt sold overseas to global investors.
India has deliberately eschewed foreign-currency sovereign borrowing and instead turned to its diaspora to tide over the occasional hard-currency shortage in the past. That was a prudent choice. Unlike export-led East Asian countries that routinely save more than they invest, India’s private sector has a chronic dependence on foreign money, particularly to pay for energy needs. But as long as the government only borrowed locally, any risk of a 1980s Latin American-style blowup because of externally financed twin deficits was kept at bay.
The government’s sudden U-turn on that long-held consensus, driven by poor growth and depleting fiscal resources, has now backfired. Nationalists saw a dollar bond as subjugating India’s interests to a global order they deeply mistrust. Internationalist technocrats, led by former Reserve Bank of India Governor Raghuram Rajan, rejected the idea that sovereign borrowing in foreign currency would be a cheaper option. After accounting for customary rupee depreciation and the occasional currency meltdown, dollar debt can suddenly grow expensive.
Granted, in a world where yield is so hard to find, there’s no dearth of appetite. Even skeptical institutions would be forced to buy the Indian paper, knowing that Asian private banks’ rich clients – especially those of Indian origin – would love to snap up the note. Even if the opportunity exists, however, should India take it?
Moody’s Investors Service rates Indonesia and India at the same Baa2 level. Indonesia sold a 2029 dollar bond last month at a shade under 3.5 per cent, slightly cheaper than the 3.6 per cent yield at which the existing 10-year note was trading. Assume the same cost, and add the roughly 5 per cent annual drop in the rupee against the dollar based on the trend in the past 30 years. The financing works out to be more expensive than the local Indian 10-year bond yield of 6.5 per cent.
But cost isn’t the only issue. A bigger problem is credibility. As I wrote at the start of Modi’s second five-year term, the new government needs to rebase its fraught relationship with investors on truth and trust. A former chief economic adviser from Modi’s first term believes the actual GDP growth rate is more like 4.5 per cent than the published 7 per cent. The Economic Times has reported that the federal budget deficit for the year that ended in March 2018 was almost 5.9 per cent, according to the comptroller of government accounts, rather than the disclosed 3.5 per cent.
Instead of acknowledging that growth is sub-par and domestic fiscal resources are nearing exhaustion, the new Modi government upset many of its supporters in finance and business by jacking up tax rates, introducing new levies, and announcing the dollar bond as an expedient solution.
With an honest appraisal, the government could have nudged banks to borrow in foreign currencies – on expensive terms – from the diaspora. That’s exactly what it did during the Fed’s 2013 taper tantrum. However, since the problem this time is of a domestic resource crunch rather than a hard-currency shortage, India can alternatively raise money overseas with rupee-denominated debt: a first-ever sovereign masala bond, as the category has come to be known.
The masala markets in London and Singapore aren’t liquid enough to get New Delhi $10 billion in one scoop. (The state of Kerala recently became the first subnational government to raise about $305 million.)
Then again, even Asian dollar bond investors may have been more than a little nervous by the size of India’s fundraising. Overall, the market has absorbed issuance in excess of $200 billion so far in 2019, up 42 per cent from a year earlier. But Sri Lanka has needed four different securities (two in March, two in June) to scoop up $4.4 billion, while Indonesia has sold three bonds, including Islamic debt, to gather $2.7 billion.
Both strategically and tactically, India’s dollar bond was ill-conceived. Some media reports suggested that New Delhi may opt to borrow in yen instead, although as Chikafumi Hodo of Bloomberg News reported, an issuance of that size would equal half of last year’s so-called Samurai bond sales. It would have been too much for Japanese investors to handle.
If India works half as hard on policy credibility, it won’t need the gimmicks.