Indian sovereign bonds will become part of JP Morgan’s Global Government Bond Index – Emerging Market (GBI-EM) on June 28, concluding decade-long efforts to secure the inclusion and attract more foreign fund inflows.
In September 2013, then Reserve Bank of India (RBI) Governor Raghuram Rajan mentioned discussions about including India in these bond indexes. “We will have conversations with the international index agencies, the entities, and some of the investment banks that create these indices. Let us see what they require, sometimes they require a pace that we have to examine before we feel comfortable with. But we will have those conversations,” Rajan said then.
In 2024, efforts to include the bonds culminated with economists projecting $25 billion in inflows over 10 months, with the inclusion happening in 10 monthly increments of 1 percentage point each, starting June 28.
While the inclusion promises higher foreign investor participation and lower domestic borrowing costs, it also raises concerns about the volatility of “hot money” flows.
The highs
Vishal Goenka, co-founder of IndiaBonds.com termed the inclusion of Indian government bonds in JP Morgan’s index a “watershed moment” for the country’s fixed-income markets.
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“This compulsorily puts Indian bond markets on the radar of global bond investors, and although initial investments are supposed to be to the tune of $25-30 billion, index inclusion paves the way for this number to keep growing in the next few years,” Goenka added.
Also read: Indian bond yields to trade in 6.75-7.00% range post JP Morgan bond inclusion, say experts
Debendra Dash, chief dealer for fixed-income at AU Small Finance Bank, estimates the inflows during July alone to be $2 billion.
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India has additional reasons to celebrate. The inclusion came without offering any tax breaks to foreign investors, which is widely seen as a norm to facilitate such a move.
For several years, the tax treatment of gains made by foreign investors from the sale of Indian government bonds once they are listed on these indices has been a point of contention between India and global index providers.
While New Delhi declined to offer favourable terms to overseas investors, experts pointed out that the capital gains tax regime was a significant constraint.
In September 2023, JP Morgan decided to go ahead with India’s inclusion a year after pointing out concerns over the potential inadequacy of domestic bond settlement systems and internationally misaligned taxation policies. It was a significant win for the Indian government, which did not make any changes or adjustments to its tax norms to assuage the concerns of the index provider.
In fact, in March 2024, Bloomberg Index Services also announced its intention to add Indian sovereign debt to its Emerging Market Local Currency Government Index from January 31, 2025.
The ponderable
There are also expectations that inclusion of Indian bonds in global indices will bring down the government’s borrowing costs thanks to an increase in foreign participation. However, experts believe that this may not be the case entirely.
Dash says the impact of the inclusion has already been factored in, and he does not see a significant drop in bond yields.
Also read: India bond inclusion may not lower borrowing costs aggressively, says Fitch Ratings’ Jeremy Zook
“The only thing we can surely say is that despite US treasury yields moving up, the cost of Indian government bonds may not move up, but a significant fall in yields is unlikely given that the amount of foreign inflows that may come in from June 28 onwards is not expected to be too large,” he added.
Dash was referring to the fact that the Indian bond market has already experienced increased investment inflows from FPIs following JP Morgan’s inclusion announcement in September 2023.
According to Clearing Corporation of India’s (CCIL) data, the fully accessible route (FAR) holding of foreign portfolio investors has increased more than 93 percent till June 26 since the announcement of bond inclusion. Currently, yields on the 10-year benchmark bond is hovering below 7 percent, 15-20 basis points lower than the levels seen around September 2023.
India introduced the FAR route in 2020 along with substantive market reforms to aid foreign portfolio investments in its gilt market.
Fitch Ratings’ Asia Sovereign Ratings Director Jeremy Zook too sees limited scope for lower borrowing costs on the merit of bond inclusion alone, given that the increase in foreign participation may not be very large.
“Bond index inclusion is modestly supportive for India. It does help diversify the investor base and lower borrowing costs, but very modestly because foreign participation is quite low at the moment. And when we see an increase in foreign participation from bond inclusion, we do not think this will be too large of a scale to bring down borrowing costs aggressively,” Zook said on June 13.
The lows
However, a major concern regarding including government bonds in global indices is the potential for volatile inflows. While inclusions are expected to boost demand for India’s sovereign debt and reduce bond yields, market participants said it will also increase global scrutiny of domestic policy.
On September 22, chief economic adviser V Anantha Nageswaran pointed out that following the bond index inclusion, the government would need to watch what foreign investors think about domestic policy, and even unrelated developments could impact local markets.
To be sure, the lack of tax concessions and the absence of a convenient platform such as Euroclear in the settlement process do present certain “speed breakers” to foreign inflows.
Fitch’s Zook expects the potential volatility from hot money flows to be limited since the increase in foreign participation due to the inclusion of Indian bonds in global indices is expected to be relatively modest in the foreseeable future.
However, Dash says volatility in the bond market could definitely increase, but given foreign inflows are likely to be modest and trickle in over a period of time, this volatility is expected to be mild.
“Hot money is part and parcel of the market,” Dash added.
