Amid US' rising debt, falling treasury-bill appeal, should you shift investment focus to RBI-issued Indian government bonds?

Time of India

11 hours ago

Appeal of US Treasuries waning
Peers facing similar issue
Relevance for India
End note
There is a metamorphosis happening in some pockets of the investment world. The nation leading as the reserve currency of the world—the United States—has been stripped of AAA status by the three big rating agencies, S&P, Moody's and Fitch. From September to December 2024, the US Federal Reserve cut its overnight rate by 1 percentage point. Since the last rate cut measure on 18 December 2024, even as the market is expecting further rate cuts, the US 10-year government bond yield has remained more or less at a similar level, apart from fluctuations. Since then, the US 30-year government bond yield has moved up by 20 basis points, or 0.2%. This represents a bigger malaise: a crisis of confidence.The US government has pumped up its fiscal deficit. The Fed has printed tonnes of money after Covid. When the government spends more and runs up a high fiscal deficit, it has to issue bonds, which are a form of loan.At present, the outstanding stock of US Treasuries is more than $36 trillion. These numbers may not ring a bell, so let's give a perspective. The outstanding debt of the US is 123% of its gross domestic product (GDP). This level is the highest since World War II. Following the war, the US economy was damaged and the government had to spend more. Since those times, nothing of that scale has happened. Arguably, the global financial crisis of 2008 and the outbreak of Covid-19 in 2020 were of a lower proportion.Obviously, the US needs external buyers for its Treasuries, that is, other governments. In 1970, 5% of the US debt was held by foreigners; in 2023, this number rose to 29%. The implication is that dependence on external sovereigns is increasing. Earlier, China was the biggest external holder of US Treasuries, as it has a big trade surplus with the US. However, China has been selling US Treasuries for quite some time. Now, it is only the third largest holder, behind Japan and the United Kingdom. A relatively lower demand from abroad leaves it to institutions within the US; heavy supply of debt looking for buyers.Let's return to the sovereign credit rating of the US. Credit rating agencies may be behind the curve, and in the case of the US, they are influenced by the reserve currency status. The market, however, is more fleet-footed. There is a metric called credit default swap (CDS), which indicates the cost of purchasing an insurance or cover against default. The cost of the US sovereign CDS today is much higher than those of countries like Germany, Japan, the UK or South Korea, while also just lower than Greece and Italy. This means that the market is placing the risk level of the US as just safer than Greece or Italy.To be clear, it is not just about the US. Japan is facing problems in selling its long maturity government bonds. Due to lack of buyers for Japanese government bonds (JGB), the Bank of Japan is forced to purchase. To an extent, this issue exists in Germany as well—few takers for long-maturity government bonds.Essentially, the bond market is giving a message to governments that if you pile up too much debt, we will either not buy or buy at a high cost, that is, at a lower price. The sovereign debt level of Japan is much higher than that of the US. Today, the yield on 30-year JGB is higher than China's, something that was unthinkable earlier.The level of sovereign debt in India is much lower than that of the countries mentioned above. Central government debt is approximately 56% of the GDP and, adding up the states, it is 83% of the GDP. When the Reserve Bank of India (RBI) sells government bonds through the usual auction process, there are enough takers.Let us look at this in the context of ownership of foreign portfolio investors (FPIs). Purchases of Indian government bonds by the FPIs have moved up since September 2023, when JPMorgan announced the inclusion of India in its bond indices. Even after relatively buoyant purchases compared to earlier, the FPI holding in Indian government bonds is only 3% of the outstanding stock. In case the FPIs pull out from India (an unlikely scenario), the markets here would feel an impact, but a limited one.Another aspect is the influence of global central banks on the RBI's interest rate decisions. Interest rate action from the US Fed or European Central Bank (ECB) does influence policy makers at the RBI, but their priority is about parameters in India, like inflation and GDP growth. Bond yield levels in our secondary market are influenced by global factors, like yield level in the US, but only so much.One metric tracked by market is the level of Indian 10-year government bond, US 10-year government bond, and the spread or differential. The higher the yield level of Indian bond, the stronger the case for FPIs to invest in the country. This spread is much lower than earlier. Indian bond yields have come down, driven by the RBI rate cuts. The mindset has to change; Indian fundamentals are better than that conveyed by the just-investment-grade rating accorded by S&P, Moody's and Fitch. The US yields need to be higher than earlier due to the reasons mentioned above.To invest in Indian government or corporate bonds, mutual funds, portfolio management services and alternate investment funds are among the available routes—or you can do so directly. You can invest in the US Treasuries through the liberalised remittance scheme (LRS) route, particularly if you have an expense in forex coming up, say, child's education abroad a few years later, to save on currency depreciation.