One, Two, Three & Bingo! Stronger Rupee & Lower Bond Yields! Here's How

Camera: Athar Rather
Video Producer: Shohini Bose
Video Editor: Vivek Gupta

The government made two major policy announcements in the first week of February 2022 – the Union Budget and the Monetary Policy. In both, it pumped the growth fist but tried to mute three frightening realities looming over India’s economy:

1. Spiking interest rates and bond yields, spooked by the government’s astronomical increase of Rs 5 lakh crore – a full 50% over the previous year – in gross borrowings

2. A crashing rupee, beyond 75-to-the-dollar

3. Spiralling oil prices, dancing perilously close to $100 per barrel

Inexplicably, the finance minister declined to welcome nearly Rs 2.50 lakh crore ($30 billion) that would have gushed in had she altered the capital gains tax rules to permit India’s treasuries to feature in global bond indices. As missed opportunities go, it was the Queen of times!

But honestly, just a couple of other smart moves can significantly alleviate this stress – but for that, our Raisina Hill bureaucrats must stop cowering in irrational fears about dollar markets.

Action #1: Boldly Go Forth With Sovereign Dollar Bonds

Remember 6 July 2019, when the same finance minister had gleefully announced a $10 billion issuance of overseas government bonds? But then, unfortunately, she scuttled it, scared by a volley of uninformed criticism.

If she were to revive that bold idea, it would be a very prudent five percent of the government’s gross borrowing programme and a mere one-and-a-half percent of foreign exchange reserves.

In one stroke, she would move the foreign currency risk on to her fiscal accounts, spread joy in domestic bond markets, and herald lower local interest rates. Of course, her ministry will have to develop sophisticated foreign risk management skills to hedge the dollar and launch nimble treasury operations in international currency markets. Yes, it could be risky during times of capital flight. But precisely because it’s difficult and risky, it’s entrepreneurial, pregnant with exciting possibilities and gains.

Unfortunately, I can already hear the naysayers, but let’s debunk each objection one-by-one:

Objection A

Volatile dollar/rupee rates will create “unquantifiable” costs in the long term

Counter

Wrong. By paying a premium of five-odd percent to hedge against future dollar rates, our costs will forever be controlled and quantifiable. While the hedged interest rate would be a few basis points higher than what the government could borrow at in local markets, these shall get compensated by the several positives that accrue on venturing overseas, including the fact that private borrowers get more cash in domestic bond markets.

Objection B

Why go overseas when FPIs (foreign portfolio investors) can now take Rs 1 lakh crore of additional rupee debt in the domestic market?

Counter

This one is specious. Because when you float a sovereign bond overseas, you access an entirely new category of lenders, over and above FPIs that are authorised to invest in India.

Objection C

Foreign investors could indiscriminately dump our bonds, creating a run on the rupee and “importing” contagion

Counter

False. Since the bonds will be denominated in dollars and traded on overseas exchanges, any “dumping” would not directly impact the rupee or domestic markets. In fact, the alternative of increased FPI exposure to rupee bonds creates exactly the “dumping risk” that is being wrongly attributed to dollar bonds

Action #2: Sell Five Percent of LIC in Overseas Market

While it’s yet to be firmed up, the finance minister virtually confirmed, by estimating her disinvestment proceeds at Rs 75,000 crore for this year, that she will sell only five percent of LIC on NSE/BSE. Since LIC could be valued between $ 150-200 billion (Rs 10-15 lakh crore), the math is obvious. Since many in the government also doubt the ability of Indian markets to absorb over Rs 100,000 crore in one shot, there is talk of breaking up the offer in two tranches of Rs 50,000 crore plus – ie, sell, burp, and sell again.

Now think a bit out of the box, think bold. Why should we slice LIC’s offering in two tranches, separated by several months, simply because we are scared our local investors may not have enough appetite? Instead, why don’t we sell half the issue in India, and simultaneously sell the other half overseas? That could raise close to $10 billion on LSE/NYSE.

Now do the arithmetic one more time:

• $10 billion from Sovereign Dollar Bonds

• $10 billion from the offer of five percent of LIC stock on LSE/NYSE

• $30 billion from a tweak to the capital gains tax rules to allow Indian treasuries to list on global bond indices

Bingo! $50 billion flow into India, bond yields soften considerably, and the rupee appreciates against the dollar. No need for desperately silent budgets or monetary policies.