What are sovereign bonds, and what are their risks and rewards?

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By Moderator July 25, 2019 14:34

News

In her budget speech finance minister Nirmala Sitharaman announced that government would start raising a part of its gross borrowing programme in external markets in external currencies

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  • According to most reports, this type of borrowing is likely to start by October with the initial amount of $10 billion.

Sovereign Bonds

  • A bond is like an IOU. The issuer of a bond promises to pay back a fixed amount of money every year until the expiry of the term, at which point the issuer returns the principal amount to the buyer. When a government issues such a bond it is called a sovereign bond.
  • Typically, the more financially strong a country, the more well respected is its sovereign bond.
  • Some of the best-known sovereign bonds are the Treasuries (of the United States), the Gilts (of Britain), the OATS (of France), the Bundesanleihen or Bunds (of Germany) and the JGBs (of Japan).

Importance

  • The issue of international sovereign bonds will have several long-term implications.
  • If the government was to borrow some of its loans from outside India, there will be investable money left for private companies to borrow
    • Indian government’s domestic borrowing is crowding out private investment and preventing the interest rates from falling even when inflation has cooled off and the RBI is cutting policy rates.
    • In fact, the significant decline in 10-year G-sec yields in the recent past is partially a result of this announcement.
  • It may facilitate the inclusion of India’s government bonds in the global debt indices.
    • India’s representation in global debt market indices is small compared to other emerging markets. This may lead to higher foreign inflows into India.
  • Inclusion in global benchmarks would also improve the attractiveness of rupee-denominated sovereign bonds.
  • The rates at which the government borrows overseas will act as a yardstick for pricing of other corporate bonds, helping India Inc raise money overseas.
    • While some commentators think that the government can borrow at very low costs overseas, this argument is weak, as it will have to hedge against forex risks.

Issues

  • Dollar-denominated bonds are more sensitive to global interest rates. Global shocks, as seen in the 2013 taper tantrums, can lead to heightened selling pressure on Indian bonds.
    • India’s sovereign bonds that will be floated in foreign countries and will be denominated in foreign currencies. In other words, both the initial loan amount and the final payment will be in either US dollars or some other comparable currency.
      • This would differentiate these proposed bonds from either government securities (or G-secs, wherein the Indian government raises loans within India and in Indian rupee) or Masala bonds (wherein Indian entities — not the government — raise money overseas in rupee terms).
    • If the loan is in terms of dollars, and the rupee weakens against the dollar during the bond’s tenure, the government would have to return more rupees to pay back the same amount of dollars.
    • If, however, the initial loan is denominated in rupee terms, then the negative fallout would be on the foreign investor.
  • Raising part of this overseas can ease oversupply of government bonds in the domestic market.
    • Since interest rates on financial products track the movement in G-Sec yields, this can reduce interest rates on loans and savings.
    • Interest rates offered on post office savings or bank fixed deposit rates can move lower, if the yields on government bonds fall.
    • Banks can also lower their lending rates.
    • The increased vulnerability of Indian bond markets to foreign flows can make returns from debt funds more volatile.

Raghuram Rajan argument

  • Rajan has questioned the assumption that borrowing outside would necessarily reduce the number of government bonds the domestic market will have to absorb.
  • That’s because if fresh foreign currency comes into the economy, the RBI would have to “neutralise” it by sucking the exact amount out of the money supply.
  • This, in turn, will require selling more bonds. If the RBI doesn’t do it then the excess money supply will create inflation and push up the interest rates, thus disincentivising private investments.

N R Bhanumurthy and Kanika Gupta argument

  • N R Bhanumurthy and Kanika Gupta have shown recently, the volatility in India’s exchange rate is far more than the volatility in the yields of India’s G-secs (the yields are the interest rate that the government pays when it borrows domestically).
  • This means that although the government would be borrowing at “cheaper” rates than domestically, the eventual rates (after incorporating the possible weakening of rupee against the dollar) might make the deal costlier.

Source: https://indianexpress.com/article/explained/explained-what-are-sovereign-bonds-and-what-are-their-risks-and-rewards-5849315/

 

Moderator
By Moderator July 25, 2019 14:34