In a significant boost to the Indian economy and the country’s global positioning, India is all set to enter the elite club of JP Morgan’s GBI-EM Global index suite, commencing from 28 June, 2024. Currently, there are 23 Indian Government bonds (IGBs) which are eligible for inclusion — in the widely tracked emerging market debt index — with a combined notional value of USD 330 billion, as per the JP Morgan statement which also highlights that inclusion of the IGBs will be staggered over a 10-month period starting 28 June, 2024, through 31 March, 2025. Thus, in effect, there will be an incremental addition of 1 per cent weightage per month for these Indian bonds in the index.
The GBI-EM GD accounts for USD 213 billion of the estimated USD 236 billion benchmarked to the GBI-EM family of indices, the JP Morgan statement adds. According to JP Morgan, India is expected to reach the maximum weight of 10 per cent in the GBI-EM Global Diversified Index (GBI-EM GD). Following the JPM announcement, spot USD/INR opened around 31 basis points lower and has since retraced higher by 11 bp, according to market record.
While Secretary, Department of Economic Affairs Ajay Seth has welcomed it as a “development showing confidence in the Indian economy,” Chief Economic Adviser V. Anantha Nageswaran underlines the confidence emanating from the fact that “JP Morgan has made this decision on their own”.
Nageswaran views it as an attestation of the confidence that financial market participants and financial markets, in general, have on India’s potential and growth prospects and its macroeconomic and fiscal policies. “Just as long-term equity investors have been amply rewarded by investing in Indian markets, so will long-term investors in Indian government bonds be,” says Nageswaran.
This inclusion is considered a major positive, as India could expect to receive close to USD 24 billion in foreign inflows over a 10-month period starting from 24 June and it will absorb more than 15 per cent of the net supply of Government securities (GSEC) for FY 25, according to Sandip Raichura, CEO of Retail Broking and Distribution & Director, Prabhudas Lilladher. “Furthermore, it is expected to reset historical spreads by 20-25 basis points downwards, resulting in a lower capital cost of borrowing for India. Additionally, the increase in forex reserves will contribute to an improved external fundamental situation for the country,” says Raichura, decoding the significance of the development.
In fact, in the context of the nation’s debt market as it has the potential to attract billions of foreign inflows. “Foreign portfolio investors (FPIs) are already entering the Indian fixed income market in anticipation of this inclusion,” says Raichura. The JP Morgan announcement to include India government bonds in its widely tracked GBI-EM indices, led to Indian rates and bond yields first rallying by 6-7 bp but then retraced 3bp of gains, according to Nomura Ratings which points out that the JP Morgan announcement had 73 per cent of investors in its favour. It has implications for bond flows as well. With USD 236 billion of AUM tracking the index, Nomura expects USD 23.6 billion of bond inflows over the inclusion period but these flows may not be released straight away, for a few reasons.
First, there could be some pre-positioning from global investors. On Nomura metrics, large investors are already holding 2-3 per cent of their funds in IGBs or India risk. In 2023 year-to-date, offshore investors net bought USD 3-4 billion of India bonds. Passive index funds are unlikely to start including IGBs until closer to the inclusion starting date (June 2024), while active funds have tracking error limits (they are not able to get to the full 10% now), the Nomura report says.
The RBI could be expected to accumulate USD, should spot USD/INR fall further on expectations of bond inflows, suggests Nomura research. After selling USD 84.4 billion (spot and forwards) in 2022 to defend INR, Nomura estimate is that India has brought USD 35.4 billion from January-July 2023 (spot and forward). However, the research estimate is that India sold USD 6.2 billion in spot since August to lean against INR depreciation pressures and amid a pick-up in foreign equity outflows. The IGBs inclusion over a 10-month period means that the monthly inflows into IGBs would only be USD 2.4 billion per month. Actual inflows may be smaller, as some real money managers tracked by Nomura may already be 2-3 per cent invested in IGBs, on average.
There are some challenges on the way, including the risk of further foreign equity outflows.
There has been USD 1.1 billion of foreign equity outflows in September-to-date after USD 15.9 billion of net foreign equity inflows this year. India is the strongest recipient in Asia except Japan. The rationale for these inflows has included factors such as a reallocation from China, the end of the RBI’s rate hike cycle, improved local growth prospects and global growth holding relatively steady. However, Nomura cautions that the risk of further outflows is rising, as sentiment is deteriorating from twin deficits and elections concerns. Furthermore, equity strategists think that elevated oil prices may also provide a reason for foreign investors to reduce their equity holdings.