Investment alert! Are Sovereign Bonds heading towards a yield benchmark in India?

The Union Budget has proposed that the Government would start raising a part of its gross borrowing programme in external markets. It is expected that Government will go for $10 billion (around Rs 70,000 crore or 10 per cent of gross market borrowings) worth of sovereign bonds initially. This amount is merely 2.3 per cent of total India’s current forex reserves and 29 per cent of net FDI flows in FY19. Incidentally, this amount is also 1/3rd of the minimum amount of sovereign debt issued in international markets. 

Elaborating upon how India is better placed into the global Sovereign Bond market Dr. Soumya Kanti Ghosh, Group Chief Economic Adviser at SBI said, "Going by the international evidence, India is best placed to tap the sovereign bond market now. Comparison with Latin American and Asian economies is imprudent and naive. For example, such countries had an average 51 per cent of debt denominated in foreign currencies /GDP, debt/GDP at 124 per cent, CAD/GDP at 6 per cent, Investment inflows at 9 per cent and GDP growth at 5 per cent just before the crisis. In contrast, India’s external debt/GDP is at 19.7 per cent, sovereign foreign currency debt /GDP at 3.8 per cent and investment inflows /GDP at 1.5 per cent. Also, the Government is not planning to go overboard with its external borrowing programme. However, we still recommend that a strong balance of payment situation (CAD is only 2.1 per cent of GDP) and a fairly stable exchange rate is a must for long term foreign borrowing and a prudential limit must be set for such borrowings as a percentage of GDP. Additionally, RBI should bring down the forward premia cost to keep the interest of FPI in existing rupee bonds." 

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Asked about the lower cost borrowing benefiting the Indian market Dr. Ghosh of SBI said, "We believe the direct benefit of a lower cost of borrowing may not be significant. This is because of the swap cost that is always associated with such borrowings. However, the indirect benefit will be significant as with the bond yields softening it will help banks to increase their bottom-line through treasury profits. This will have a positive impact on provisioning ratio of the banks. We envisage that the treasury profit to provisioning ratio of Indian banks would touch new highs in FY20, reminiscence during FY02 to FY04."

Standing in sync with the SBI views; Anindya Banerjee, Deputy Vice President — Currency and Derivatives at Kotak Securities said, "The RBI has done well by providing Rs 80,000 crore liquidity to the PSU banks, which is expected to go up to Rs 2 lakh by September 2019. It will help them bridge the gap between the Repo Rate and Government Bond yields." He said that Indian bond market is going to become a major beneficiary of the FII investment in coming times as its yield is one of the highest in the world and the Indian equity market is already at its peak.

So, the Modi 2.0 Government has to now, take the bond issue as a starting point for encouraging further capital inflows and consider the complementary issue of attracting FDI as a cornerstone of supplementing domestic with foreign capital.