Sovereign Overseas Bonds & Finance Ministry’s Decision: Impact Adaptability Solution

, August 2, 2019, 1 Comments

India’s Gross Government Debt as a Percentage of GDP lies between 61-68 Percent till 2019-2023, unless some drastic measures. (IMF Forecasts, 2018-19), which is comparable to China and lower than Advance Countries Projections of Government Debt to GDP.sovereign-overseas-bondsIn such a case, Sovereign Overseas Bonds denominated in Foreign Currency were a solution offered by Finance Ministry of India for raising foreign funds for India’s future Development.

The repercussion of raising Sovereign Overseas Bonds with no effective Hedging  is as follows:

  • Demand for Dollars, yen (Source of Currency denominated bonds) in India will rise if Foreign Currency denominated Bonds are used and a Depreciated Rupee would be the result.
  • Spill-over International  Inflation would rise due to Rupee Depreciation.
  • Foreign Exchange Reserves kitty would depreciate too viz- a viz other Currencies.

one-MarketExpress-inFirst Proposed Solution: Adaptation of Currency Forwards with Sovereign Overseas Bonds

Hedged Foreign Exchange driven Sovereign overseas dominated Bonds like Currency Forwards implying, fixed rate of borrowing viz-a viz in mentioned rate of Exchange in Foreign Currency Forwards in Bonds for money to be exchanged on a future Date. Eg. If lets say RBI want to get into Sovereign Overseas Bonds at 1 Dollar= 65 Rupees. So, when the Market Rate to the dollar becomes, 1 Dollar = 68 Rupees, The Government would have lost 3 Rupees per lot of the amount issued had Over the Counter Forward hedge for the Sovereign Overseas Bonds  had not been done. The above solution is just an adaptation of Currency Forwards with Sovereign Overseas Bonds and a hybrid measure that could be a  more Ministry of Finance or Government Driven Strategy.

How did RBI gain on the Over the Counter Currency Forward Hedge (Mostly Inexpensive, done by the Central Banks of the countries)?

For a simple Over the Counter Currency forward as done by The RBI on its funds, RBI generally gains the difference of 3 Dollar per lot of the amount hedged and that is parked as its profits on the Contingency Funds by simple Over the Counter  Currency Forward hedge by the RBI.

two-MarketExpress-inSecond Solution: Over the Counter Currency Collars mixed with Sovereign Overseas Bonds

Another Solution is like there are Interest Rates Collars, A collar is created by purchasing a cap or floor and selling the other. The premium due for the cap (floor) is partially offset by the premium received for the floor (cap), making the collar an effective and simple way to hedge rate risk at lower cost.  In return for the same, the hedger gives up the potential benefit of favorable rate movements outside the band defined by the collar. Similarly, the Ministry of Finance can have Over the Counter Currency Collars mixed with their Sovereign Overseas Bonds. A Currency Collar by purchasing a cap or floor and selling the other. The premium due for the cap (floor) is partially offset by the premium received for the floor (cap), making the collar an effective and simple way to hedge rate risk at a lower cost. Let’s say, here the floor could be 1 dollar =65 and Cap could be 1 Dollar = 70/72 Rupees.

three-marketexpress-inThird Solution: Swaptions with Sovereign Overseas Bonds

Swaptions, which is Swaps plus Options, which are hybrid instruments, Government should have the right to exercise the same or not, only loss will be the premium.
RBI generally does Vanilla Swap whereby the exposure is converted into fixed or floating Exchange Rates dependent on the condition on what’s profitable at what time. Plus, in Swaptions, RBI has an authority to refuse a pre- fixed deal based on loss of premium and convert it into a Swaption.

Similarly, Sovereign Overseas Bonds could have a Swaption Criteria where their interest rates, payments on the Bonds could have an Option like Case Scenario whether, it is more profitable for the Indian Government to give which preferred interest Rate.

four-marketexpress-inFourth Solution: Credit Default Swap by the Foreign Country against The Ministry of Finance with minimum Premium

Over the Counter Credit Default Swap for the Overseas Sovereign Bonds (which is Third Party Involvement by paying Premium in case of future Default)

Credit Default Swaps (CDS) act as a sort of insurance against a probable loss of an asset. Banks can hedge their risks by paying a premium to the seller of CDS and hedge itself against a probable credit loss on the Asset (Loan provided) by availing recovery of the loan from the seller of CDS in case of default. If a probable loss on the asset (underlying Listed Corporate Bond) is expected to the buyer of the CDS, the protection seller will make payment for the same.

As it’s the Finance Ministry is drafting the future Course of Borrowing for the next 5 years, hybridization of the contract is possible.

The future lies in the drafting of Hybridized Contracts by the International Government Ministries Borrowing and Lending in letting their International Government Debt to GDP Ratio to fall further.