Motilal Oswal
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Motilal Oswal
April 11, 2018 08:16 PM | Bonds

Government’s sovereign bond issue is a terrible idea, says Pronab Sen

India's bond yields surged in Wednesday's trade, fuelled by inflation concerns. However, yields started softening marginally on reports that the government is mulling sovereign bond issue in the overseas market in FY19.

If the government goes ahead with this move, it will be a first for India. Ashima Goyal, member of PMEAC and Pronab Sen a former chief statistician, discusses the issue.

Q: Sovereign bond issue is this a good idea?

Sen: It is a terrible idea in short.

Q: Why?

Sen: For the very simple reason one of the things that we have to recognise is that if the government owes debt to its citizens there can never be a case of sovereign default. It is simply not possible. The problem always occurs when the government owes debt outside. This is the problem all over Latin America, this was the problem in Greece so anywhere where government have actually borrowed abroad they have run into problems.

Japan like us has stayed off sovereign debt completely. I think it is a terrible idea. It is opening a flood gate which can lead to disastrous consequences.

Q: Would that be an argument that we are testing the waters it will be a limited issue and therefore one shouldn’t imagine that you will go the Latin America way just because we are borrowing USD 4 billion, I mean USD 4 billion would be what Rs 24,000 crore out of a total government borrowing of 6,00,000 crore should one really worry?

Sen: No, the problem is all of these things start with small numbers. India is a very large economy. So, it doesn’t sound like very much. The point is that do you as a matter of policy open a door which says that if I run into a balance of payments problem I will go abroad and the government will borrow money from the market rather than go through other means. We have done all kinds of borrowings which have been government induce, but it has never been sovereign debt. I think it is a door best left closed.

Q: What about the argument that foreign borrowers are also great disciplinarians and therefore the very fact that a rating action or earning the ire of a foreign investor of foreign markets can discipline governments better?

Sen: It is already happening. I mean remember the foreign markets are already influencing you through foreign portfolio investment (FPI). Now whether that money is coming here for government securities or for private securities doesn’t really matters that much. The fact is that in terms of our balance of payment (BOP) finance the FPI money is important. That is about all the discipline that you need.

Q: On a separate note the idea of a sovereign bond is being whispered precisely on a day when there is the news of oil going above USD 71. The government will after a point not want to pass on especially in a year dotted with elections and then it will have to bring down its excise hikes, its excise duty on petroleum. That will mean a fiscal breach. Do you think our fisc is already under threat in the current year with oil being the way it is?

Sen: Not really, you actually think about it. If anybody expected oil to hang around USD 40 a barrel there were living in a fool’s paradise. We were seeing predatory pricing being done by Organization of the Petroleum Exporting Countries (OPEC) essentially to drive the shale oil producers out of business. It worked up to a point, but then they couldn’t maintain it for very long.

Now what you should expect to see going into the future is essentially a two person game. OPEC on one side and the shale oil producers on the other. I would imagine that you will see oil yo-yoing within a fairly limited band of somewhere between USD 60 and 80. As far as our fisc is concerned, let us recognise another fact of life which is that the government increased the tax to mop up the difference between USD 80 which was its own reserve price and whatever the global price was.

Now surely, until we hit USD 80 the government cannot complain that they have been unfairly hit. If they had gone and overspend that money or over committed those funds that is just bad planning.

Q: That is usually the case, the money that was earned from lower crude prices through excise hikes have already been spent or committed?

Sen: No, spend by all means, there is no need for you to hang on to it. But don’t spend it on anything which is of a recurring nature which becomes an ongoing liability that is the question.

Q: The argument that Pronab Sen is making that it always starts small and we all know the example of Latin America and what sovereign borrowing did to those countries, therefore don’t even start, that door is best left shut.

Goyal: I believe in homeopathy, so a little bit of poison helps you become stronger. When you test the markets, you require experience, you get rated abroad etc and it imposes some fiscal discipline. However I believe that predominantly you have to develop domestic market. General advice is that your domestic market must be deep before you allow any of this foreign or even domestic debt inflows. We have been holding it as a low percentage of the total turnover which is very healthy. We must recognise that it is a tail, it can’t wag the dog and we must now allow it to wag the dog because sometimes the problem is even though it is a small amount, policy tends to over-react or over worry about what will happen to those flows.

Q: USD 140 million of IMF loans was a tail that did wag the dog many years ago, we were a smaller economy then.

Goyal: That was a larger percentage of the total market. Now you have grown, so this USD 4 billion or whatever is a very small percentage of the total market.

Q: We already are getting market discipline as Pronab Sen pointed out. FPIs invest upto 5 percent, now 5.5 percent of domestic bonds, is not that market discipline enough? Do we really have to expose ourselves to a dollar denominated sovereign bonds?

Goyal: As long as it is a very small quantity of total government borrowing and it remains that then it is not unhealthy.

Q: Do you think the fisc is under threat with crude going to USD 71 per barrel and a year dotted with elections when the government will be vary of passing it on to consumers?

Goyal: I heard Pronab Sen talking about this. I agree with him largely on his points. I would just like to add that for us USD 70 per barrel because we earn from nations that gain when oil prices are higher in terms of remittances etc. So, the government gets taxes. We have had a slowdown, we were expected to gain from very low oil prices but we did not, slowdown continued. So, I think we are seeing a recovery as oil prices become more normal. At this level it is healthy for the oil market itself because you have supply being built otherwise you have supply and then an overshooting when demand rises. So, it is healthy for oil markets, healthy for global demand and it is healthy for our remittances and other export earnings which will lead to an increase in government revenue. So, it is not necessary that rise in oil prices stays within our comfort band and is necessarily bad for fisc.

Q: The point that Ashima Goyal is making that a little bit of poison is good so long as we are able to keep that sovereign bond amount limited to USD 4 billion, you agree or disagree?

Sen: I disagree. She may believe in homeopathy, I believe in yoga which is abstinence.
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