Why India must issue dollar and euro bonds
India will then have sovereign yield curves in the world’s reserve currencies, which should help our companies raise money at lower rates
If you are a foreign investor investing in rupee-denominated government bonds, you are primarily worried about two things. Will the government pay back in full and what will the value then be of the rupees converted to your base currency? That is, you are worried about intention and exchange rates. What you are not worried about is capability—the government can always create new rupees. Similarly, if you are investing in Indian sovereign debt denominated in the dollar, the credit risk remains, but the currency risk goes away if the dollar is your base currency. In theory, the capability risk is also there, but practically speaking, the Indian government can almost always print rupees and buy dollars. Separating the credit and currency risks explicitly can lead to an overall lower risk premium.
As it so happens, the Indian government does not have any outstanding foreign currency-denominated direct debt. Also, the Indian government has never defaulted on any of its debt. Moreover, we have never remotely come close to hyperinflation. The combination of these facts means that we are missing a serious trick here. Consider a few more facts. Indian 10-year sovereign rupee yields are almost at 8%. Compare that not with Germany (0.5% in euros), or Spain (1.5%), but with the latest crisis country in the European Union—Italy (less than 2.5%). The ratings are very similar —India has a higher Moody’s rating than Italy (Baa2 vs Baa2-) but Italy has a higher S&P rating (BBB vs BBB-). It is another matter that even these ratings are biased. If something goes wrong, Italy cannot print euros but India can print rupees.
What the market is saying is that if you hold both Indian and Italian gilts for 10 years, and if both come good, and if the rupee depreciates by at least 5.5% (7.9-2.4%) annually against the euro, only then does choosing Italian bonds make sense. That is, expect the rupee to be at almost 140 against the euro in 2028 if these prices are “fair”. But even if euro area’s inflation becomes more Japanese than American and undershoots 2% (by “achieving” 1%) and even if India overshoots its target of 4% (reaches 5% despite inflation targeting and a string of hawkish central bankers), that still adds to a difference of only 400 basis points (bps).
Yet, even if the difference in inflation is somehow an annualized 550 bps going forward, India, as the fastest growing major economy in the world now, is almost certain to see real effective exchange rate appreciation (as per the Balassa-Samuelson effect). Indeed, the Bank for International Settlements data shows that the Chinese real effective exchange rate appreciated by 90% since January 1994 and India’s by just 5% (Indian per-capita growth, a rough proxy for productivity in tradable goods and services, was much slower compared to China during this period). And it is important to remember that the purchasing power parity to market exchange ratio for gross domestic product in India is almost two times that in China. This should put to rest the lazy regurgitation of many that India’s currency is “fundamentally over-valued”.
Or, maybe it is not the currency risk but the credit one. This is exactly where having an Indian euro-denominated government bond would help. Investors can then forget about the currency and just think if giving money to Italy—or even Spain—at a lower yield compared to India makes any sense. The Chinese, last year, issued US dollar-denominated bonds at incredibly thin spreads: just 15 bps for five years, and 25 bps for 10 years. While the bonds marginally sold off later, they were nonetheless massively oversubscribed and the spreads achieved were better than many higher-rated countries. Even if the Indian 10-year US dollar bonds have a spread of 95bps (much worse than the Chinese) over treasuries, we would be able to raise at 4%. This leaves a differential of almost 4% with rupee gilts.
Issuing Indian gilts in dollars makes sense as the US has the world’s deepest bond markets, and issuing in euros also makes sense as it allows a more “like-to-like” comparisons with different euro member states. Yen bonds would also be interesting. A clear roadmap of issuances should be announced so that foreign institutional investors (FIIs) are assured they are not left with illiquid paper.
India will then have sovereign yield curves in the world’s reserve currencies, which should help our companies and infrastructure investment trusts raise money for less. That along with the proposed inflation-adjusted bonds should lead to a more “complete” bonds-currencies-derivatives market, something we have been sorely missing even as we had world-class equities trading markets. It is true that “synthetic” dollar-denominated Indian gilts can be created through derivatives. However, the market microstructure is not conducive for liquid, friction-free trading and there are regulatory and tax barriers. Finally, the aim here is not to raise capital for the government but to have a benchmark for FIIs, so that they can make a more rational lending decision for other Indian entities.
In the end, it all boils down to trust. The Indian state has earned this trust over seven decades; it is now time to use it for our massive developmental needs. Even as the West sees an about 35-year-old bond bull market coming to an end, India could see a similar long cycle (the last extended Indian gilt bull run was during the Atal Bihari Vajpayee government). One small step in that journey is to break out of the mental cage of rupee-only government bonds.
Harsh Gupta is chief investment officer of Ashika Investment Managers.
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