Explained: What are sovereign bonds, and what are their risks and rewards?

  1. Finance Minister has announced in the Budget that it plans to raise a portion of its gross borrowing from overseas markets using sovereign bonds.
  2. A government bond or sovereign bond is a form of debt that the government undertakes wherein it issues bonds with the promise to pay periodic interest payments and also repay the entire face value of the bond on the maturity date.
  3. However,the current controversy relates to India’s sovereign bonds that will be floated in foreign countries and will be denominated in foreign currencies.In other words,both the initial loan amount and the final payment will be in either US dollars or some other comparable currency.
  4. This would differentiate these proposed bonds from either government securities wherein the Indian government raises loans within India and in Indian rupee or Masala bonds wherein Indian entities and not the government raises money overseas in rupee terms.
  5. The difference between issuing a bond denominated in rupees and issuing it in a foreign currency such as US dollars is the incidence of exchange rate risk.
  6. If the loan is in terms of dollars and the rupee weakens against the dollar during the bond’s tenure,the government would have to return more rupees to pay back the same amount of dollars.However,if the initial loan is denominated in rupee terms,then the negative fallout would be on the foreign investor.
  7. Further,the Indian Government is borrowing from overseas markets as Indian government’s domestic borrowing is crowding out private investment and preventing interest rates from falling even when inflation has cooled off and the RBI is cutting policy rates.
  8. Moreover,at less than 5%,India’s sovereign external debt to GDP is among the lowest globally.In other words,there is scope for the Indian government to raise funds this way without worrying too much about the possible negative effects.
  9. The sovereign bond issue will also provide a yield curve a benchmark for Indian corporates who wish to raise loans in foreign markets.This will help Indian businesses that have increasingly looked towards foreign economies to borrow money.