Theoretically, JPMorgan’s decision to include Indian government bonds (IGB) in its emerging markets government bond index appears to be a game changer. The move is expected to channel $25-30 billion of foreign funds into India’s government bond market. The increased participation of foreign investors in the Indian bond market could enhance the market’s depth, help reduce the government’s cost of raising funds, incentivise the government to pursue favourable macroeconomic and fiscal management policies—a long-standing market demand—and also improve India’s external balance sheet by way of higher forex reserves, and stabilise the rupee’s valuation against the US dollar. However, in practice, there may be uncertainties along the way that could make achieving these objectives a challenge. India’s inclusion in JPMorgan’s Government Bond Index-Emerging Markets (GBI-EM) will start in June 2024, with the global financial giant set to increase India’s share in the index by 1 percentage point every month until it reaches a weightage of 10 per cent by March 2025. “We estimate that FPI (foreign portfolio investors) ownership in IGBs should rise to 4 per cent by FY25, and further to a minimum of 6- 7 per cent over the next two to three years from the current 1.4 per cent, assuming that the share of other participants remains around similar levels,” states a report by Nuvama Fixed Income Research. A report by Fitch Ratings, however, states that foreign investors currently own a fairly small percentage of IGBs available to them, so their influence on debt pricing is likely to be limited. Market experts suggest that the ideal holding should be 10-15 per cent of the total stock, at which point their participation may become more meaningful. While FPI inflows in IGBs are expected to constitute less than 5 per cent of the overall stock of outstanding bonds post inclusion, its impact from a one-year perspective would be substantial. “In the upcoming fiscal, the government is expected to issue approximately $150 billion of government bonds, with FPIs expected to pick up bonds worth $25 billion, accounting for more than 15 per cent of the total issuance,” says Parul Mittal Sinha, Head of Financial Markets for India and Co-head of Macro Trading for Asean and South Asia at Standard Chartered Bank. “From a one-year standpoint, this could potentially have a substantial impact.” But, she cautions that from a longer-term perspective, a holding of less than 5 per cent will not be as material. Further, the expected inflow of $25-30 billion will not be limited to passive funds tracking the index. “There will also be an inflow of active investments, which, based on experiences of other emerging market countries, could range from $5-10 billion. But this money could be more volatile in nature, and be dependent on short-term expectations of market movements,” Sinha adds. The idea—to push for the inclusion of Indian rupee bonds into global indices, which is indeed a bold one—was initiated by the government three years ago. Under the fully accessible route (FAR) created by the Reserve Bank of India, non-residents were allowed to invest in government bonds without any restrictions from April 2020. The Government of India issues approximately $200 billion worth of government bonds annually. “Of this, almost 75 per cent falls under the FAR category. The 40-, 50- and 3-year bonds do not fall within the FAR classification, while the remainder does. The FAR securities are increasing sharply in number and quantum each year,” explains Sinha. Further, the inclusion, being hailed as a positive for the rupee in terms of initial flows, also has the flip side of high volatility in capital flows, and the consequent impact on the rupee’s value against the US dollar.
Today, the yields on Indian bonds are better than EM bonds. For instance, the weighted average nominal yield for the JPMorgan GBI-EM index is close to 6.25 per cent, while the yield for IGBs is around 7.25 per cent. With India offering a significant advantage, market watchers believe investors may be overweight on India. “There will be a fair amount of investor interest because India’s currency has outperformed other EM currencies. The rupee has remained stable, and bond market volatility has been minimal. Year-to-date, the rupee has depreciated by less than 1 per cent against the dollar,” emphasises Sinha. That apart, foreign investors are expected to keep a watchful eye on the macroeconomic fundamentals of the country, as the government securities market is closely linked to macroeconomic indicators such as inflation and fiscal deficit. “While some key parameters such as fiscal deficit to GDP, government debt to GDP, and current account deficit as a percentage of GDP will be monitored, nothing is looking alarming at the moment,” says Dhawal Dalal, CIO for Fixed Income at Edelweiss Asset Management. But India’s fiscal management track record leaves much to be desired. Since the global financial crisis of 2008, the country’s fiscal deficit has consistently been over 3 per cent. The stimulus introduced during the Covid-19 period had partly impacted India’s fiscal consolidation journey, resulting in a higher deficit. But post Covid-19, the government has set a glide path towards a fiscal deficit of 4.5 per cent by FY26. Also, the deficit is being pegged at 5.9 per cent of GDP for FY24 and gross market borrowings at Rs 15.54 lakh crore for the fiscal. The government’s borrowings widen the size of the fiscal deficit and fuel inflation, which leads to higher interest rates. Further, the share of interest payments—close to one-fourth of the government’s total expenditure in the annual budget—has been increasing steadily in recent years. “A higher share of interest payments limits the government’s ability to spend on important priorities, such as infrastructure, education and healthcare, among others. It also makes the government vulnerable to rising interest rates,” says a banker, requesting anonymity. The Fitch report states that there are past examples of governments—whose bonds form a part of benchmark indices—pursuing economic policies that had clear adverse effects on the confidence of foreign investors. “We do not believe that inclusion in the JPMorgan GBI-EM index will significantly affect India’s fiscal policy approach,” it notes. But market participants are also anticipating a freeing up of domestic capital as a result of the expected inflows. They suggest, the move would mean that $25-30 billion worth of domestic capital would now be available for the corporate bond market. But some experts suggest that the corporate bond market is available only to high-rated corporations. As other major bond index providers like Bloomberg and FTSE Russell consider including Indian bonds in the future, it is crucial to carefully monitor JPMorgan’s initial inclusion, and learn from the experience as Indian bonds embark on a new chapter. @anandadhikari