A major development which took place last week was the news of the inclusion of Indian bonds in the JP Morgan bond index for emerging markets. This has been a long-standing expectation which will finally materialise in June 2024. This development fits in with the global face that India has exhibited throughout the year which hence does justice to the effort put in over the last few years to make India truly global. In a way it is an acceptance of India’s economic strength.
In simple language, Indian government securities would be a part of the global index of JP Morgan. The weight assigned for Indian bonds will be around 10% in the index and their inclusion will be gradual over time starting at a rate of 1% per month. By March 2025, the total weight will be 10%. This means that any fund which buys the index in global markets would automatically be investing in Indian bonds. This is so because index investment, which is probably the most popular form of passive investment, will allocate every dollar to the components of the index and hence there will be demand for these securities. It is said that 23 such securities would constitute this 10% allocation.
Intuitively it can be seen that FPI investment will increase in the debt segment. Today, investment is permitted but not more than 20% of the permitted limit gets absorbed as interest is limited. With the inclusion in global indices, there will be automatic interest generated. Further, just like how funds trade in specific scrips of the Sensex which behave in a certain manner when the index moves, there will also be additional interest in buying such securities in the bond index. Hence there will be secondary interest too in GSecs.
The immediate advantage is that there will be more dollars flowing into the market. Hence the pressure on domestic investors, which are primarily the financial institutions, will come down. In fact, banks will have more space to lend to the commercial sector. On the other hand, as these 23 securities are already issued, the demand for such paper will rise leading to a decline in yields assuming the status quo in other financial conditions. Hence typically once included in the bond index, interest rates could move downward in the market. The beneficiary will be the government as it will be able to raise funds at a lower rate, other things being the same. The benefit for corporates or households will not change as their borrowing rates will continue to be linked with the repo rate that is guided by inflation perspectives.
There is hence some reason to be excited about this development. Prima facie it appears that there can be around $ 25-30 bn that can come in once the share of Indian government bonds in total goes up to 10% of the total weightage in the index. This may not be a large amount, but considering that flows have been whimsical so far, a steady inflow will be useful to strengthen the balance of payments situation. The collateral effect is that once included in a global bond index there will be a nudge to other owners of indices like Bloomberg, Morgan Stanley, and Goldman Sachs etc. to also include Indian securities. This is so because often traders arbitrage across indices thus adding to the volume of transactions. Hence, this can be another positive outcome for India.
One must however remember that just as FPI flows have boosted the stock market as well as flow of foreign exchange, there are good chances of withdrawals too which can spook the market. Hence it will also be necessary for other institutions like mutual funds to step in and support the market though admittedly they will be constrained by their investor preferences. But it may be useful for the market to evolve stabilising traders who can offer support when there are erratic swings inflows. These swings can be caused both by perceptions of the Indian economy or even extraneous developments.
For example, a high fiscal deficit of the government or even a failure of a disinvestment process can cause ripples in the bond market. At the same time, a decision of the Fed to do away with the support of the liquidity programme can lower the quantum of investable funds thus causing a withdrawal from emerging markets. Or at times investors may just like to book profits which can cause a sale in the market. This is something that we have to be prepared for which is the case with any developed and evolved market.
The immediate reaction to the news was positive with bond yields coming down by 5-7 bps. But it has been back to normal subsequently. So clearly the benefit will be seen only when the inclusion actually takes place and funds come in. In the interim period, there could be certain positions taken in the market in anticipation of the inclusion in the index which can add some buoyancy to the market. This however needs to be monitored.
The inclusion of Indian government securities in the bond index is also a strong signal sent to the global credit rating agencies that they need to take a different view of India’s sovereign rating. If the trading community now recognises the strength of the Indian economic story, there is the reason for an upgrade for sure. This is definitely signaling a victory for India that it is not just the FDI investors but also the market investors who smell great opportunity here.
The author is Chief Economist, Bank of Baroda and author of ‘Corporate Quirks: The Darker Side of the Sun’. Views are personal