Bloomberg India bond inclusion to bring $1-2 billion inflows: What's ahead?

Bloomberg will be adding India to its Emerging Market Local Currency government bond index (EMLC GBI) from end-January 2025 with the total weight of 10 per cent staggered over 10 months. Similar to the JPM GBI-EM, only Fully Accessible Route (FAR) securities will be added to the index.

Emkay Global said the massive new foreign flows will bring a problem of plenty for the RBI ahead, as it manages the impossible trinity of managing foreign exchange, new foreign flows, and independent monetary policy back home.

It noted that 37 per cent of the outstanding government securities (G-Secs) are FAR bonds (FAR outstanding: $456 billion) and incrementally, 75-80 per cent of new G-Sec issuances are now FAR bonds.

"That said, unlike JPM GBI-EM which is tracking an estimated AUM of $230-240 billion, the BBG EMLC GBI is a much smaller index, tracking an estimated AUM of $10-20 billion, implying that passive flows into India could be between $1-2 billion only. However, inclusion in the massive BBG Global aggregate index may get delayed to 2025 once they test waters with this smaller index. We hear that India’s weight in this massive GAI, as and when added, may be 0.5-0.7 per cent," Emkay Global said.

The domestic brokerage said that the meagre passive flow of $1-2 billion contrasts with possible passive inflows of $23 billion through JPM GBI-EM inclusion as a one-off stock adjustment over the scale-in period from end-June 2024

However, active FPI flows owing to the announcement effect have already been pouring in significantly since September, it said.

"We note that net FPI debt inflows in FYTD24 have been a huge $13 billion vs outflows of US$1.1bn in FY23. Foreign ownership of FAR securities has shot up to 4.4 per cent from 3 per cent as of September-end 2023. Going ahead, the investable universe via FAR for FPIs will increase over the years," it said.

Emkay said most major global bond indices had highlighted major impediments in India’s inclusion on account of factors like capital controls, FPI capital gains taxes, non-adherence to Euroclear requirements, restricted market access and operational issues just two years ago.

It does not think India is in any rush to become Euroclear-compliant in the near future.

"However, the recent progress on resolving operational issues, such as posting margin requirements and extended settlement times, have been instrumental in India securing these GBI inclusions. There were also media reports that Indian government is in talks with BBG and other platforms to provide an interface for FPI G-Sec trading, which also will improve settlements of G-Secs," i said.

Prima facie, the macro impact of GBI inclusions is positive overall and structurally, all of this will lower India’s risk premia/cost of funding across curves, including corporate bonds, enhance the liquidity and ownership base of G-Secs and help India finance its fiscal and CAD and could trigger positive externalities.

"We have already seen India G-Sec secularly trending down since September 2023 and is now hovering near 7.05 per cent. This has been helped by FPI demand via the demonstration effect, while domestic G-Sec demand by players across segments has been healthy and is likely to remain so in FY25 as well, especially with players like insurance and pension structurally seeing healthy growth in their AUMs," it said.