AUGUST 06, 2019

By Naresh Minocha, Consulting Editor

THE Government's Johnny-come-lately plan to enter global sovereign debt market (SDM) has stirred a lively debate.

Is it an attempt to create a new link to converge resource pools for managing fiscal deficit (FD) and current account deficit (CAD)? If not, then what is the big deal in appearing on a platform on which many developing countries such as Maldives and Benin have already made their mark?

Are there not better alternatives to reduce cost of servicing government debt, thereby making easy FD management? Is indirect, regular tapping of global debt market through Government enterprises such as EXIM Bank, State Bank of India, Power Finance Corporation not aiding management of twin deficits?

Is the Government geared to make full disclosures to foreign regulators for seeking approval of maiden overseas bond offer?

Before taking up such questions, recall what Finance Minister Nirmala Sitharaman stated in her maiden budget speech on 5th July. She said: "India's sovereign external debt to GDP is among the lowest globally at less than 5%. The Government would start raising a part of its gross borrowing programme in external markets in external currencies. This will also have beneficial impact on demand situation for the government securities in domestic market".

This sounds over-simplistic. It does not give correct picture of underlying challenges in managing macro-economy.

It is highly unlikely that Finance Ministry officials explained her fully all the implications of this out-of-the-blue idea. No wonder Prime Minister's Office has reportedly advised the Ministry to review this proposal. The advice merits serious, critical scrutiny of proposal.

Start with disclosures that the Government would have to make in the prospectus /offering circular/offering memorandum for the maiden bonds/notes offer overseas SDM. The depth, degree and accuracy of disclosures depend on the stock exchange where the bonds are to be registered & listed.

It is here pertinent to quote a working paper (WP) published last year by European Central bank. Titled 'Foreign-law bonds: can they reduce sovereign borrowing costs?' WP says: "Governments issuing bonds to borrow from capital markets must decide about the bonds' governing law. From the investors' perspective, sovereign bonds governed by the laws of a foreign jurisdiction are less risky than domestic-law bonds".

WP explains: "Domestic-law bonds can have weaker legal protection since the bond contract terms can be altered retroactively by changes in the law of debtor countries. Through an act of parliament, governments can, in principle, change the payment terms of domestic-law bonds, their currency denomination, or the voting rules for a potential restructuring. Such a retroactive change of contracts is not possible for foreign-law bonds, because legislation by national parliaments has no authority beyond domestic borders".

From Indian standpoint, the benefit lies in restricting sovereign borrowings to the domestic market, where foreign institutional investors (FIIs) already have notable presence.

Issuance of bonds under regulations of United States Securities Exchange Commission (SEC) can be ruled out straightaway as disclosure requirements are too stringent. Indian Government would feel uncomfortable in answering too many queries that might be raised by SEC.

In all probability, Modi Government would choose between European and Asian SDMs. If it opts for Euro area market, it would have to seek approval of a central bank of the country where proposed bonds would be registered and listed.

To know what disclosure sounds like, take a look at Oman's Base Prospectus dated 19 July 2019 for its global medium term notes (GMTN) programme.

According to the document, this base prospectus has been approved by the Central Bank of Ireland "as competent authority under Directive 2003/71/EC, as amended or superseded (the Prospectus Directive). The Central Bank only approves this base prospectus as meeting the requirements imposed under Irish and European Union (EU) law pursuant to the Prospectus Directive".

Would Union Finance Ministry and Reserve Bank of India (RBI) be comfortable with idea of answering queries from European regulatory bodies? If Government decides to avoid such scrutiny, it might go for easy option: Launch bond offer at Singapore Exchange Securities Trading Limited (SGX-ST). It is already a favourite destination of both Indian public and private companies for offering Medium Term Notes (MTN) and Senior Notes to foreign investors.

A typical statement in offering circular thus reads: "The SGX-ST assumes no responsibility for the correctness of any of the statements made, opinions expressed or reports contained herein. Approval in-principle from, admission to the Official List of, and the listing and quotation of any Bonds on the SGX-ST, are not to be taken as an indication of the merits of the Issuer or the Bonds".

Another standard disclosure in offer document given to SGX-ST goes on these lines: "Neither the U.S. Securities and Exchange Commission (SEC), any state securities commission nor any other regulatory authority has approved or disapproved the securities nor have any of the foregoing authorities passed upon or endorsed the merits of the Offering or the accuracy or adequacy of this Offering Circular".

A standard disclosure in OCs for both Asian & European stock markets runs like this: "Any representation to the contrary is a criminal offence in the United States".

This rider is incorporated keeping in view perhaps the fact the issuer circulates privately OC to select qualified institutional investors based in the US.

Turn to specifics of Indian situation. Finance Ministry has not disclosed whether the maiden issue would be for medium or long-term notes or a mix of both. It is not clear whether the Government is eying green bonds.

According to 'OECD Sovereign Borrowing Outlook 2019' "Sovereign green bond issuance has been gaining momentum in Europe. The main goal of adding a new instrument to financing securities is to attract a broader and more diversified investor base in line with long-term cost and risk minimisation objectives".

There is no compelling reason for the Finance Ministry to enter overseas capital market to finance its FD in hard currency. Such borrowings imply the need to hedge against foreign exchange rate fluctuations. The long-term trend of rupee depreciation can't be reversed until and unless India is able to improve its export competitiveness and give a big push to exports.

The key to determining the net cost advantage of offshore bonds lies in projecting depreciation of rupee against the currency in which bonds are denominated. It is a tricky job. There might be cost disadvantage if global commodities' prices flare up, hitting both FD and CAD.

The Government's regular presence into overseas debt market can constrain companies' scope to enhance the number and frequency of their offerings. As it is, Indian companies' borrowings in foreign capital markets are small as compared to the debt mopped up by Chinese companies. Indian corporate sector has not yet ventured out much of Singapore-based market.

Why can't Government improve guidelines for external commercial borrowings by public, private and cooperative sector enterprises? An instance of a cooperative resorting to ECB is very hard to come by. Similarly, why can't Government enhance the ceiling of domestic sovereign bonds securities that can be subscribed by FIIs?

The advantage of FIIs subscribing to domestic issues is that the risk of foreign exchange fluctuations is borne by them, not by the Government.

According to Finance Ministry's Report on India's External Debt 2017-18 released last month, there has been a noticeable increase in the share of rupee denominated debt in total external debt from 20.5% in 2012 (end-March) to 35.8% in 2018 (end-March), due to increase in FII investment in Government securities.

Has the Government explored the option of efficient and enhanced tapping of loans offered by multilateral development finance institutions such as the World Bank?

Does it hold itself accountable for foregoing a few billion dollars every year by aborting project proposals when they are at an advanced stage of negotiation?

Is it not averse to undertaking reforms that form part of loan proposals?

And last but foremost reason to not borrow abroad lies in fiscal discipline. Why can't Government simply improve expenditure efficiency & rein in avoidable expenditure? Why is it indifferent to the need for reintroducing zero-budgeting technique to usher in fiscal discipline? Should there not be limit on populism-driven dole-outs to vote banks?

The Government has thus bucketful of issues to ponder over before deciding to plunge into offshore SDM. Issues apart, key financial indicators don't make a case for offshore foray.

Take the case of the interest cost of cumulative Government debt. The ratio of interest payments to revenue receipts (IP-RR) has been declining for both the Centre and States' debt.

According to Status Paper on Debt issued by Finance Ministry in December 2018, "Average interest cost (AIC) is arrived at by dividing interest payments during a year with average debt stock. A continuously declining average interest cost augurs well for the stability of Government debt. Trend in average interest cost of both the Centre and States showed a downward movement since 2000".

Similarly, Debt-GDP ratio has been on the decline. Central Government Debt is estimated to be 48.0 per cent of GDP in 2019-20. Continuing the declining trend, it is likely to further reduce to 46.2 per cent in 2020-21 and 44.4 per cent in 2021-22.

As put by Medium Term Fiscal Policy Cum Fiscal Policy Strategy Statement that forms part of 2019-20Budget, "Efforts in inflation control will benefit the Government in medium term with lower inflation reducing the cost of fresh borrowings of GoI, resulting in reduction in interest payout. A progressive reduction in debt-GDP ratio of the Government will ease the interest burden and allow more space to the Government to spend on other socially productive sectors without taking recourse to additional borrowings".

All this analysis shows that there is no urgency to launch maiden issue in offshore SDM. There is, however, an urgency to improve expenditure efficiency, reduce wasteful expenditure and impart stability to business environment for reversing economic slow-down.