Foreign capital inflow will ease down the bond yield to some extent
Union budget 2022 is few days away and there are speculations around inclusion of India’s sovereign bond in the global bond index. Sometime back RBI governor said that the process is on and it should happen in few months. Historically, India has remained averse to the foreign ownership in the country’s debt. This policy choice was largely driven by our experience related to balance of payment situation in 1990s. Government opened up the corporate sector for foreign capital (via FDI/FIIroute) and even FPI limit in corporate bond was kept high but RBI continued to keep a conservative stand on sovereign bonds. Things have changed now and our foreign exchange reserve is enough to withstand the short-termvolatility caused by sudden capital outflow. The Covid pandemic has curtailed revenue generation on one hand while public spending has increased on the other. The Government has resorted to borrowing as other non-tax receipts (like disinvestment proceedsor asset monetisation schemes) are lagging behind the target. The GOI 10-year bond yield has touched two years high of 6.54 percent in January 2022. Economic growth is still under the shadows of pandemic and therefore government borrowing is unlikely to come down drastically. When economy revives and credit demand picks up, banks would not be showing the same appetite for the Government papers and it appears that yields are not going to ease in near term. A higher yield means more outflow on account of interest payment and thereby leaving less amount with government for infrastructure and asset creation.
Foreign capital inflow will ease down the bond yield to some extent. However, this inflow will cause appreciation of INR and it will be detrimental to the exporters. This exchange rate movement can be managed by the RBI with its market interventionpolicies. Despite of various concessions and incentives given by government, private investment is not picking up and government has to come forward for almost all major infrastructure projects.Domestic borrowing directly impacts the liquidity which has direct impact on demand/consumption and inflation.In our case, external borrowing should be used for growth purpose only and foreign capital should not be tapped just to finance the fiscal deficit.Country’s risk perception determines the demand of the government papers by the buyers. Credit Default Swap spread isgenerally used to gauge the risk perception on the securities issued by the borrower. India’s five-year sovereign CDS spread has consistently fallen (after reaching its peak in March’ 20 due to Covid-related uncertainty)which means that credit perception has improved. India’s sovereign credit rating has remained stable and downgrading by Moody’s in June 2020 from Baa2 to Baa3 had invited severe criticism. Attractive yields on Indian bonds are remunerative to the foreign investors even if exchange rate risk is factored in and therefore demand of these securities is not a question which policy makers should worry about.There are certain areas which needs to be clarified by the RBI and finance ministry before this policy shift sees the light of the day. Though there is an overall ceiling of six percent and two percent of outstanding loans for central Government and state development loans respectively, operational process should be smooth. Taxation aspect (both interest receipt at periodic interval and capital gain) is important as any relaxation to the foreign investors would be detrimental to the domestic investors. A concession to the foreign investors while taxing the transaction in the hands of domestic investors would go against the principles of equity. This structural shift shows change of mindset and it is a welcome step but will needto be monitored cautiously post implementation.
(The writer is a Chartered Accountant, author and public policy analyst. The views expressed are personal.)
