As budget surprises go, there was little to beat finance minister Nirmala Sitharaman’s 5 July announcement that India would go overseas to partially fund its borrowing plan for the year, setting the stage for the country’s first ever sovereign bond issue in foreign currency. The excitement among some investors is palpable. External debt would mean that much less domestic funds would be sought by the government, which in turn would reduce yields in the Indian bond market, help banks pass on policy rate cuts to their loan customers, and ease credit availability to the private sector in general. The added advantage is that interest rates in the West right now are especially low, and so foreign money can be raised quite cheaply—at less than half the domestic rate, by one estimate. With India’s overall external debt just about one-fifth of its gross domestic product, over-indebtedness is not a big worry. Yet, it would serve us well not to rush forth with an issue without a close analysis of what it could expose the country to.
Take the exchange rate risk entailed. If the rupee weakens over the tenure of the paper, the government’s payback burden would increase, since it would take more rupees to buy each dollar, euro, yen, etc. This risk can be hedged, no doubt, but doing so against a sharp rupee decline—or, say, a global economic shock—would cost a lot. That’s not all. On a macroeconomic level, a large foreign bond issue could well tilt India’s broad policy frame in favour of a strong rupee. Sure, the central bank’s stated stance on currency markets is to intervene only to contain excessive volatility, not to guide its direction, but what an economy is geared for makes a significant difference. In trade theory, a floating exchange rate moves up and down with the demand and supply of the currency for the purpose of imports and exports; currency shifts make products cheaper or dearer and thus act as a mechanism to balance trade. In the real world, however, the rupee’s value is largely determined by capital inflows and outflows. An inward gush of dollars often pushes it up, even as exports get outpriced and suffer. Coupled with a need to lighten the payback burden, an over- dependence on foreign investment might leave our exports even less competitive, which would make it harder to pursue export-driven economic expansion, East Asian style.
While dollar bonds are a temptation, their broader impact could be harsh. Not that India should junk the idea. Government estimates peg the sum to be raised overseas at around $10 billion this fiscal year, about one-tenth of the total borrowing plan. This proportion looks manageable. It’s unlikely to worsen India’s vulnerability to external factors. Also, if Indian sovereign bonds become part of international market indices, their prices would set a reliable interest rate benchmark for overseas credit sought by Indian firms, which should ease their access to foreign loans. But if sovereign issuances slip out of control, with more and more bonds being hawked that heighten risks in ill-understood ways, then it would be a case of a bold idea gone bad. Taken on recklessly, foreign debt could pose threats to the Indian economy that local policy actions may not be able to neutralize. New Delhi would be well advised to adopt a measured approach. Study every aspect of it closely, and then proceed with due caution.