India should open door wider to global bond buyers
If India wants to expand companies’ access to funds, deepen the bond market, increase risk appetite and manage the effect of government borrowing, it will have to abandon its fear of global capital
Hoping to jump-start its “Make in India” manufacturing push, India’s government has rolled out the welcome mat for foreign investors. It should consider doing the same for global bond buyers.
Indian bonds are, at the moment, suffering a full-scale rout. On Monday, yields on benchmark 10-year government debt—called the “G-sec” rate in India—continued their slow creep upwards to 7.78%. Many expect them to cross eight percent at some point in the next few months. How swiftly have things turned bad? Well, as recently as last August, G-Sec yields were south of 6.5%. By the end of February, bond prices had fallen for seven successive months, the longest decline in two decades.
The market’s gloom reflects how badly India’s macroeconomic fundamentals have weakened. Last year, the economy seemed to have vanquished the threat of constantly rising prices; markets now worry that inflation is back. The Reserve Bank of India sounds distinctly hawkish. Over the past year or so, there’s been a flood of new bond issues from India’s states.
Most importantly, the federal government, faced with a difficult political situation and looming elections, has abandoned its hard-won reputation for fiscal restraint. In its last federal budget, India missed its fiscal deficit target. Worse, the budget math looks distinctly dicey, which suggests the government is going to be even more profligate next financial year. The ruling party is trying hard to woo angry Indian farmers through enhanced price supports for grains. That would be a pretty nasty one-two punch for the bond markets: It would both weaken government finances and drive up inflation expectations.
High yields have complicated things for the government. It isn’t just that its borrowing costs are going up; the yields also threaten India’s already stressed state banks. In January, the RBI’s deputy governor warned that Indian banks were sitting on too many government bonds and thus taking on too much interest-rate risk. What he was actually telling banks was that they shouldn’t expect any help from the RBI in moderating that risk: “Interest-rate risk of banks cannot be managed over and over again by their regulator,” he said.
Indian banks are holding far more government securities than they’re required by law, so their profits have been hit particularly hard by the bond rout. Of course, now they’re trying to sell off the excess, which has only pushed up yields even further. This comes at precisely the time when banks are facing extra provisioning requirements to address their giant bad-asset problem. Meanwhile, their principal shareholder, the government, is pushing them to lend more to companies to revive private investment.
Can India’s government do anything about this, or must it simply push through the pain? Well, if you’re worried about the price of something falling, you can either increase demand for it or reduce the supply. Certainly, given the government’s spending and borrowing plans, there doesn’t seem to be much that can be done about the excess supply of bonds.
What about demand? Perhaps there was a time when the government could have simply ordered state-owned banks to mop up the extra paper. But that, given the banks’ parlous state, is no longer an option.
At the same time, the government seems to be shrinking the market for corporate bonds. A recent report suggested that India’s state-owned pension fund could lower the number of corporate bonds it holds from 35% of its portfolio to 20%. India’s corporate bond market is already massively underdeveloped; it’s only 15% of bank credit to industry. If you really want it to grow, you have to increase the number of buyers and deepen state institutions’ appetite for risk.
There is one thing the government and the RBI can do to stabilize the bond market—rethink India’s habitual paranoia about “foreign” money. In September 2015, the amount of rupee-denominated government debt that foreigners could buy was raised—but still limited to 5%. Investors are also constrained by a $51-billion limit on foreign investment in Indian corporate bonds. The RBI adjusts the G-Sec ceiling every now and then, but usually only to try and attract “long-term” investors.
This paranoia is inexplicable. There’s a fear of instability, of foreign investors forcing a crisis. But that is something that usually happens in countries that have sold too much dollar-denominated debt to outsiders. It’s difficult to see how rupee-denominated debt would have the same problem.
If the government wants to expand companies’ access to funds, deepen the bond market, increase risk appetite and manage the effect of government borrowing, it will have to abandon its fear of global capital. Let foreign buyers eat their fill of Indian debt. After all, that’s the basic engine of capitalism: India is where the growth opportunities are and it should and must attract capital from places with less-inspiring returns. By keeping foreigners from lending us money, we’re hurting ourselves most of all. Bloomberg View
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