JP Morgan announced on Sept 22 morning that it will include Indian government bond into its Government bond index- emerging markets index suite starting June 2024. The news came as a savior for Indian stock markets as they did pretty well on Sept 22 despite Gift Nifty was showing a big fall due to weak global cues. Short term trends aside let’s take a look on what this inclusion means in medium to long term.
Analysts believe that this inclusion could bring $25-30billion of inflows into the country. JP Morgan announced that country could reach maximum 10 percent weightage in GBI-EM Global index. This should be seen as a major win for current government as inclusion efforts were being made from 2013 but that time economy was battling ‘taper tantrum’ that sank the Indian rupee to its(then) all time low in late August, but that time inflation was very high and confidence of investors in economy was low.
The newly appointed RBI Governor Rajan that time made efforts for deal to go through but there was differences in thoughts between involved party as meeting point was not reached and this consensus gap was due to bad shape of economy that time. Now after 10 long year JP M decided to include India. While experts welcome the move they also throw light at reforms(social and economic) that have been made by government in past few years.
Even now when talks resumed after this government took charge and talks begin again Finance ministry was not in mood to compromise as it had drawn a line and was not willing to cross to become a member of these global bond indexes. A major obstacle between India and these index providers has been the tax treatment for gain made by foreign investors from the sale of Indian govt bonds once they are listed on the indices. Their demand was a more flexible taxation to overseas investors.
That unwillingness of getting listed in bond indexes had a lot to do with Economic recovery that India had since this new govt took over. For example India had all time high foreign exchange reserve(an indicator of economic wellness) of $641 billion in Sept 2021 against $274 billion in Sept 2013. It was just from India’s part to not get over excited about getting into these indexes as it would have been resulted in many policy changes that may have effected it in a negative way. Staying to the term India is comfortable with is still a very commendable decision.
This inclusion mean that JP Morgan fund mangers appeared to have agreed to terms India was offering, this may be cause of tumultuous emerging markets like Russia, China and several others getting their weightage reduced or completely removed. On the other hand, In India inflation too appears to have been brought under control, and interest rates might not see large increases. There are chances that similar bond indexes will follow the suite to include Indian government bond into their indices, FTSE Russel and Bloomberg-Barclays are such similar major bond indexes.
The inclusion Methodology
India, which will be included in the GBI-EM Global index suite starting June 28, 2024, will only contain government bonds. A total of 23 Indian Government Bonds (IGBs) with a combined notional value of $330 billion are said to be eligible. All fall under the category of “fully accessible” for non-residents.
“India’s weight is expected to reach the maximum weight threshold of 10% in the GBI-EM Global Diversified, and approximately 8.7% in the GBI-EM Global index,” JP Morgan said. The inclusion will extend over 10 months with 1% increments on its index weighting, with India expected to reach the maximum weighting of 10%, JP Morgan added.
As per the Index-inclusion criteria, eligible instruments are required to have notional outstanding above $ 1 billion (equivalent) and at least 2.5 years remaining till maturity. At the start of the inclusion on June 28, 2024, only FAR-designated IGBs with a maturity date after December 31, 2026, will be assessed for eligibility. Any new Index-eligible FAR-designated IGBs issued during the phase-in period will also be included.
JP Morgan says inclusion of FAR-designated IGBs in the GBI-EM Global/Diversified indices is estimated to increase index yields by 33 bps and 8 bps, respectively, upon completion of the staggering process. The duration for GBI-EM Global and GBI-EM GD is expected to extend by +0.19 years (to 5.34) and +0.24 years (to 5.22), respectively.
What benefits will inclusion bring?
Fund Inflow
Fund inflow and visibility on global indices will be two most important benefits that this inclusion will bring together. A Goldman Sachs report said the move could prompt passive inflows of around $30 billion (comprising emerging market local dedicated funds, as well as blended funds) over the scale-in period as a one-off stock adjustment.
However, given India’s attractiveness from a yield and (low) volume perspective, it could attract at least another $10 billion of active flows. “So in total, we think India’s fixed income markets could see inflows upwards of $40 billion over the next one and a half years (where the phase-in period will be completed by March 2025),” the Goldman Sachs report said. It also mentioned, several emerging markets dedicated funds are already set up on India, the flows will be front-loaded, beginning immediately, as investors pre-position for inclusion next year.
Reducing borrowing cost for government
India’s fiscal deficit is remaining elevated since covid happened due to high borrowing, govt plans to borrow up to ₹6.55 lakh crore through sale of bonds in the second half of 2023-24 and this inclusion will certainly benefit the govt by reducing the borrowing cost. Analysts see the price of the 10-year benchmark 7.26%, 2033 government bond, which is trading at 7.13% yield on Monday, nearing 7-7.05% by September end.
India’s fiscal deficit, which is expressed as a percentage of the country’s GDP and difference between government’s total expenditure and revenue, stood at 6.4 per cent in 2022-23, and 6.7 per cent in 2021-22. With this facility available government will opt this route to borrow bringing down the cost pressure.
Inclusion will also improve credit rating of Indian sovereign debt as increase in forex reserves will contribute to an improved external fundamental situation for the country. At present, S&P Global Ratings has given a BBB- rating to India’s credit. Lowering bond yield will also support currency due to foreign capital inflow and will benefit in managing rising crude and other import prices better but RBI may intervene if volatility is high to maintain currency competitiveness.
Improvement in government bond liquidity with JP Morgan inclusion
Though liquidity has improved in Indian bond market in recent years but it is still low compared to other similar markets. There are many reasons behind it.
- Dominance of government bonds: Government bonds account for the majority of the Indian bond market. While government bonds are generally considered to be highly liquid, their trading volumes can be lower than those of corporate bonds in developed markets.
- Lower participation of foreign investors: Foreign investors play a relatively smaller role in the Indian bond market than they do in developed markets. This is due to a number of factors, including capital controls and regulatory restrictions.
- Lack of depth in the corporate bond market: The corporate bond market in India is relatively underdeveloped. This means that there are fewer corporate bonds available to trade, and trading volumes can be lower.
Despite these challenges, there have been a number of positive developments in the Indian bond market in recent years. The Reserve Bank of India (RBI) has taken a number of steps to improve liquidity, such as introducing electronic trading and settlement systems. The government has also taken steps to attract more foreign investment into the bond market. As a result of these efforts, liquidity in the Indian bond market has improved.
Now with inclusion of Indian Government bonds into JP Morgan EM bond index it is expected to attract billions of dollars of fresh foreign investment into the Indian bond market. This would broaden the investor base improving market liquidity and making it easier for the Indian government and companies to raise capital.
Enhanced internationalization of the rupee
The inclusion of Indian bonds in the JP Morgan GBI-EM is also likely to boost the internationalization of the rupee. This is because foreign investors who are tracking the index will need to buy rupees in order to invest in Indian bonds. This would increase demand for the rupee and help to strengthen it against other currencies. But RBI will keep a close eye on the moment of Rupee and interfere whenever necessary to maintain competitiveness of Rupee with other currencies.
What next?
It can pave the way for Indian bonds to enter other indexes as The JP Morgan GBI-EM is the largest emerging market bond index and India’s inclusion into the JP Morgan GBI-EM is likely to pave the way for its inclusion into other indices as well, which would further increase foreign investment inflows. One of the other major index provider The FTSE Russell index review is still pending on September 28, but several factors have contributed to optimism about India’s inclusion. IGBs are on the watch list for inclusion in the FTSE EMGBI Index and they qualify for inclusion in the Bloomberg Global Aggregate Index.
Inclusion in to Bloomberg Global Aggregate Index [BGAI] could bring an inflow of 12-14 billion on operational ease, as possible weightage would be around 0.6-0.7 percent in the index [based on the amount of outstanding bonds]. Still some other analysts are skeptical about JP Morgan inclusion leading to other bond index inclusion namely the Bloomberg Global Aggregate Index and the FTSE Russell World Government Bond Index as they need Euroclear-ability for settlement and a higher sovereign credit rating, which India currently doesn’t have.
Conclusion
Overall, the inclusion of Indian government bonds in JP Morgan’s GBI-EM is a positive development for the Indian economy. It is expected to attract billions of dollars of fresh foreign investment, reduce borrowing costs, enhance the internationalization of the rupee, and pave the way for inclusion into other indices.
With improving liquidity in Indian bond market expectations are market will do well, improve further in future and if not in short term and in some time later other bond index providers will have to come to terms to include India in their respective bond indices as financial attractiveness of Indian economy is solid and yield is comparatively better.
No the risks that can be reason behind big correction in stock market going ahead.
