On July 13, Raghuram Rajan, the esteemed economic thinker and former policymaker, wrote an article denouncing the various pitfalls of initiating sovereign borrowing in foreign-denominated currency. While no one can deny that Rajan has excellent clarity of thought, the article came up short in terms of objectively analysing the consequences of such a crucial decision. It focussed on one side of the argument while bypassing legitimate benefits of further developing our financial system to enable borrowing through external currencies, especially dollar-denominated debt. 

He begins by downplaying the importance of the fact that “India’s sovereign external debt to GDP is among the lowest globally at less than 5%”. He states India’s sovereign external debt is low because past policymakers worried about the risks of issuing in foreign currency. While it is true that past policymakers have shied away from tapping external currency debt, it does not mean that we should always insulate ourselves in the future as well. Changing circumstances call for affirmative adaption from policymakers. India is no longer a third-world economy facing chronic and extensive problems. 

Presently, India is, in fact, a highly-desired investment destination which no major economy can ignore. Given this situation, it would be rational to capitalise on the space that a lower external debt to GDP ratio offers to us. On the other hand, being ultra-conservative and overcautious can cost us when we refuse to take opportunities where risk to reward ratio is in our favour. 

Secondly, Rajan states that “if the government wants to attract more foreign money to supplement domestic savings, it does not need to issue a sovereign bond, all it needs to do is to increase current ceilings on foreign portfolio investment into government rupee bonds. The effect is the same–more foreign inflows–but the government security is issued in rupees”. Here, Rajan fails to take into consideration that many deep pocketed and long-term investors would not prefer rupee-denominated debt. Just as Rajan is prudently considering the risks of foreign currency debt, many foreign institutional investors are also worrying about the same. Rupee denomination of debt makes for an unattractive feature for many investors who do not want to take the headache of currency risk. Rajan is not comfortable taking currency risks but expects others to take the same which is illogical. India has not yet developed to such an extent that we dictate terms on all fronts and it can ill afford to do so. Once the currency risk is out of the picture, India will become a far more attractive option for investors.

Thirdly, he posits that “there seems to be some confusion over whether a foreign dollar issuance will reduce the amount of domestic government bonds the domestic market will have to absorb. The reality is that if the RBI sterilises the foreign exchange inflows (as some commentators advocate) by buying dollars and selling its holding of government bonds, it will not reduce the domestic government bonds the market has to absorb an iota.” Here Rajan displays roundabout thinking by venturing into hypothetical analysis. Basically, issuing foreign currency debt will definitely improve market absorption of domestic bonds but it will be neutralised if, and there is a big IF here, RBI resorts to sterilising the foreign exchange inflows. Unless Rajan is still privy to policymaking in the RBI, he has no basis to speculate on RBI decisions. Since the Finance Minister has clearly stated in her Budget speech that this decision will have a positive impact on domestic bond markets, there is no reason to believe that the RBI will negate the benefits unless the costs outweigh the benefits.

Next, Rajan elucidates that this decision is being taken under the influence of foreign bankers who would stand to gain from this decision. Even if we give him the benefit of the doubt that there was lobbying for such a move, it alone does not refute the benefits of issuing foreign currency debt. He goes on to make reasonable and valid arguments regarding the risks of such a move. To quote him: “in my experience, they (foreign bankers) usually started by saying that such borrowing would be cheaper because dollar or yen interest rates are lower than rupee interest rates. This argument is bogus–usually, the lower dollar interest rate is offset in the long run by higher principal repayments as the rupee depreciates against the dollar. Moreover, times when the rupee depreciates significantly (such as during the Taper Tantrum) are times when India’s image amongst international investors is bad, and the higher repayment requirement on dollar debt could lead to even greater market turmoil.” These are perfectly legitimate concerns that policymakers need to take under their consideration.

Undoubtedly, India does face higher risks under some contingencies. Thus, it would be advisable to not go overboard with the issuance and limit it to a level that we can handle even in the toughest of circumstances. Also, having a smaller portion of foreign currency debt would mean that we do not face undue damage if “hot money” decides to dump us. With adequate safeguards and firewalls, the Indian economy has the capacity to withstand volatility or financial turmoil that may arise in the future.

However, his next argument leaves a lot to be desired. “The bankers typically shifted arguments once again–this time to emphasise that foreign trading would enhance liquidity in government issuances. Perhaps, but if that trading were done in India (by encouraging those investors to buy and sell G-Secs in India), would not the liquidity of local trading increase yet more? Do we want stronger Indian markets or stronger foreign markets?” This sort of quasi-protectionism is akin to taking two steps backwards to take one step forward and it is strange to see such thoughts coming from Rajan. There is no doubt that foreign trading would significantly enhance liquidity as western markets are far more developed than local markets. Overall, it also leads to more linkages with markets by improving the feedback mechanism and making the rates even more market-determined. As a champion of free markets, it is not expected from Rajan to make such retrograde comments. There is also an added advantage of tapping the excess liquidity which is sloshing in the market currently. 

Rajan also ignored a potential upside that can arise through external currency debt. In an uncertain trade and economic environment, there are very few safe options for investors to take refuge in. Safe Havens like Germany are able to reap the benefit of negative interest rates for their long-term bonds. India presents an interesting opportunity for foreign investors as the impact of a trade war on the Indian economy is negligible. We may be in for a positive surprise as dollar-denominated issuances of our debt may be lapped up by eager investors who want to take advantage of the unique position that India is in. An economy which is least affected by the vagaries of a trade war. Increased demand for our debt will thereby improve the yields of our domestic bonds as well.

Being prudent and conservative can be positive attributes in an uncertain global environment. But being over-conservative and being blind to opportunities is not a positive trait. In a high aspiration society like ours, it makes sense to make the most of the opportunities which are on the table. For too long we have isolated and insulated ourselves in the name of risk aversion. 

It’s time we came out of our policymaking shell and take positive steps where potential costs are less and benefits are higher. Only then we will be able to take the right steps towards the transformation of our economy. Sovereign issuance of foreign currency debt does have its risks but it also has its fair share of rewards to make up for the risks. Our policymakers should be risk aware while they take such steps so that we reap the benefits while keeping costs in check.