India mulls steps to insulate bond markets from any abrupt outflows post index inclusion

The addition of Indian government bonds in JPMorgan’s global indices in June is expected to bring in billions of dollars. The authorities are nevertheless concerned about the impact of possible large outflows

The addition of Indian government bonds in JPMorgan’s global indices in June is expected to bring in billions of dollars. But with authorities concerned about the impact of potentially large and sudden outflows, the Centre and the Reserve Bank of India (RBI) is considering steps or a mechanism to mitigate any adverse consequences of the same on the local debt market once sovereign bonds become part of these global indices starting June 2024.

The measures could look to “restrict inflows”, a person with direct knowledge of the matter said. “We are discussing how to take care of concerns around sudden outflows on account of expectations of more inflows with the global bond inclusion, though this is something that will play out only later, around 2025. But it is a very active area of discussion.”

India hasn’t diluted its sovereign rights or taxation norms to get the inclusion, but worries over hot money are still very much there, the person told Moneycontrol.

JPMorgan Chase & Co said September 22 it would include Indian government bonds in its Government Bond Index-Emerging Markets (GBI-EM) global index suite from June 2024. India’s weight in the index will progressively increase to 10 percent by March 2025.

Economists have pegged the quantum of inflows following this development at $24 billion over a 10-month period. Although investors tracking global bond indices are seen as long-term and stable, Indian authorities are still concerned about the impact that sudden, large outflows could have on financial markets.

Global scrutiny

With India unable to control the exit of foreign portfolio investors from government securities under the Fully Automatic Route (FAR) – only these bonds maturing after 2026 will become a part of JPMorgan’s indices – one way to limit the impact of any abrupt outflows could be a mechanism to “restrict inflows” to start with, the person said, given the concerns over volatility.

The person declined to elaborate on the precise nature of the restrictions being considered because the discussions are at a nascent stage. The finance ministry and the RBI did not respond to emails and messages seeking comment on the matter.

The FAR category, introduced by the RBI in March 2020, allows non-residents to invest in certain government securities without limits. At present, only 2.5 percent of the Rs 28.5 lakh crore worth of FAR securities are held by FPIs. This number is expected to increase in 2024-25.

While India’s inclusion in the global bond indices is expected to boost demand for its sovereign debt and reduce bond yields to as low as 6.5 percent, some market participants said it will also increase global scrutiny of domestic policy.

Also Read: JPMorgan’s Sajjid Chinoy says bond index inclusion shouldn’t alter RBI’s FX strategy

On September 22, chief economic adviser V Anantha Nageswaran pointed out that following the bond index inclusion, the government would need to keep an eye on what foreign investors think about domestic policy and even unrelated developments could impact local markets.

“That is something we need to be prepared for and also think about,” the government’s top economist said, adding that it was not necessary that bond or foreign exchange market volatility would increase because of India becoming a part of global bond indices.

“And if there is (increased volatility), we are used to handling volatility. Our central bank is very well experienced in managing currency and interest rate volatility,” he said.

To be sure, the lack of tax concessions and the absence of a convenient platform such as Euroclear in the settlement process does present certain “speed breakers” to foreign inflows. But concerns have also been voiced about “Ivy League-educated fund managers” – who may not have on-ground knowledge about India – reacting en masse in a knee-jerk manner to comments by key global organisations such as the International Monetary Fund.

(With inputs from Siddharth Upasani)