Sovereign Bondage… For A Few Dollars More
To paraphrase ‘Hotel California’, issuers of sovereign bonds end up as prisoners of their own device, writes Shankkar Aiyar.
The power to do good is also the power to do harm. Milton Friedman’s profound observation in his seminal work, Capitalism and Freedom, is applicable to the domain of public policy too. The announcement in Budget 2019-20 of the government's intention to issue sovereign bonds to raise “a part of its gross borrowing programme in external markets in external currencies” could well end up as an exercise in pious policy paving the way to perdition.
There is no quarrelling with the intent. The challenge before the economy is to expand the pool of resources to fund the aspiration of higher growth to eventually attain the goal of ‘$5 trillion by 2024’. The principal basis for economic growth is best illustrated by the fable where the crow drops pebbles in the pitcher for the water to rise – juxtaposed, the pebbles represent investments and the rise in the level of the water denote GDP growth.
Arithmetic Of Economics
It is arguable that raising dollar resources via sovereign bonds could help overcome the constraint of inadequate domestic savings – correct the consumption curve, ignite investment, cushion the currency and lift liquidity. India’s savings rate is trending below the long-term average, export growth is sputtering, dollar inflows are uncertain, consumption is corralled by cramped credit and idle capacity has detained new private investments.
The seductive power of the thesis of dollar stimulus-triggered growth, however, is challenged by the construct of necessary and sufficient conditions, which defines outcomes.
The availability of additional resources by itself is no guarantee of a virtuous outcome. The notion that higher growth can be engineered without addressing the structural rigidities is deeply flawed.
Yes, India did manage higher growth between 2004 and 2007 amidst systemic dysfunction but it was riding four years of four-plus percent expansion in world GDP.
That is not the case now and the ‘India Story’ is enveloped in a fog of negatives. The government balance sheet is under severe stress. Agrarian distress has already imposed costs and debt on public finances. The opportunity to expand the footprint on the global supply chain, created by shifting of manufacturing from China, is being leveraged by the Vietnams of the world. India’s exports are hurting for credit and the perpetuation of inflexible labour laws. Poor job creation and income growth have impacted consumption and savings. It will take more than bond optics to reverse the vicious cycle.
History Of Bondage
The prescription of sovereign bonds is wrapped in combustible risks and calls for an interrogation of history and understanding of the hypothesis of the ‘the original sin’ coined by Barry Eichengreen and Ricardo Hausmann. Context is critical for design of policy. By definition, developing economies lack resources and must tap global savings. The votaries of sovereign bonds point out that the need matches demand for long-term creditworthy paper funds hunt for.
The flip side to the win-win proposition is the potential risks of lose-lose scenario. Sustainability of debt and credit worthiness of the paper rests on many variables and is essentially an informed call on known unknowns. The causatives could be a downturn induced by loss of trade and unemployment or exogenous – like the Paul Volcker monetary regime which drove up the cost of capital and triggered a cluster of crisis in Latin America in the 1980s, or the end of quantitative easing which sent emerging currencies into a roil in 2013.
The chronicle of sovereign bonds issuance is charred by episodes of crises whether in the emerging economies in Latin America or in the developed economies in Europe, and has gifted the policy lexicon with choice coinages such as the Tequila Crisis and acronyms such as PIIGS to define clusters in crisis.
The Mexican experience is particularly illustrative – private capital funded industrialisation was waylaid by profligacy by the state, resulting in the need for the Brady bonds bailout followed by large-scale privatisation of state enterprises and liberalisation under what is today known as the Washington Consensus. The episodes of crises perpetuated uncertainty triggering inflation, currency depreciation, economic stagnation and flight of capital. The cycle of exuberance and despair continued for over two decades causing economic stagnation and political disruptions virtually bankrupting the nation.
The risks of dollarising sovereign debt are well documented. Any aggravation can trigger a vicious cycle of interest rate hikes, inflation, deeper deficit and debt, deflation in the exchange rate and a crisis of confidence. Typically the curatives drive the afflicted deeper into debt. To paraphrase the lyrics of the evergreen song Hotel California, issuers of sovereign bonds end up as prisoners of their own device.
History is witness to nations being drawn into sovereign bondage for a few dollars more.
Romancing the Bond
The need and the lure of dollar resources have been regular visitors in India’s policy landscape primarily to boost forex reserves – for instance via the India Development Bond in 1991 and subsequently with the Resurgent India Bond in 1998 and the India Millennium Bond in 2001.
The idea of issuing sovereign foreign currency bonds made a strong appearance during the Atal Bihari Vajpayee regime first in the aftermath of U.S. sanctions following the nuclear tests, when Yashwant Sinha was finance minister and again in 2003 when Jaswant Singh succeeded him. The contention was that a sovereign bond would get a better response and rate and would lower the benchmark rate for domestic currency sovereign debt. On both occasions, the government of the day was dissuaded by the Reserve Bank of India from doing so.
The call to cease and desist was persuasively presented by YV Reddy who, having been on the frontline in fighting the fires of the 1991 BoP crisis, made a strong case for an alternative mechanism.
The so-called nuclear option of babudom popped up again during the UPA tenure as a means to fund infrastructure and in 2013 to stem the slide of the rupee. At every occasion, the political executive has yielded to wiser counsel and chosen a less risky option which kept out the sovereign. The bonds were issued under the aegis of the State Bank of India which enjoys quasi-sovereign status.
It is Not Different Now
The lazy response to historical reference is often a vacuous and nebulous ‘India is different now’. Well, it is not. Consider expenditure management. The enactment of the Fiscal Responsibility and Budget Management Act in 2003 was aimed at institutionalising discipline in spending and eliminate revenue deficit. This is yet to materialise.
Successive governments have institutionalised the pretend-and-extend routine.
Even at the camouflaged level, India’s fiscal deficit is higher than economies with a similar rating. This year the Government of India will earn around Rs 20 lakh crore and spend over Rs 27 lakh crore. To bridge the gap it will borrow over Rs 7 lakh crore and spend nearly a third of its income to pay interest on past borrowings.
Fact is, the issues which haunted it in the nineties continue to daunt its migration from potential to performance. Yes at $2.8 trillion India is four times what it was in the 1990s. In essence, the risks of exposing delicate vulnerabilities are exponentially higher. The issuance of a sovereign bond demands transparency and a plethora of disclosures. Imagine if the team on the road-show is asked why the budget used revised estimates instead of provisional actuals in the budget, or is questioned on the postponing of—or offshoring of—expenditure on to the balance sheets of public sector enterprises?
Hosannas are sung regularly on the level of foreign exchange reserves. It is true that they are far better than they were in the 1990s and in the new millennium. Yet, the very fact that India had to rush to seek extraordinary arrangements twice in five years to protect its currency is a testimony of fragility. India consistently needs foreign inflows of around 2 percent of its GDP to sustain growth and fund its imports. Nearly three decades after 1991 its share of world exports is just 0.5 percent.
To bolster the intent to issue sovereign bonds, the budget speech stated that India’s sovereign external debt is among the lowest and under 5 percent of GDP. But that is precisely the instructive lesson the votaries of the sovereign bond are missing.
India has sustained growth and escaped another 1991 despite a 60 percent government-debt-to-GDP ratio because the borrowings have been in rupees.
Yes, India must raise additional resources and in dollars to finance the aspiration for high growth. Why not raise dollar resources by listing LIC? Why not aggregate surplus land with government into a land bank and call for bids? Why not transfer government ownership of public sector banks and enterprises into an exchange-traded sovereign fund?
The yen to dollarise government debt with sovereign bonds instead of monetising assets is perplexing, to say the least. It is what Adam Smith would characterise as a case where imagination is baffled by facts.
Shankkar Aiyar, political-economy analyst, is the author of ‘Aadhaar: A Biometric History of India’s 12-Digit Revolution’; and ‘Accidental India’.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.