JP Morgan chase & Co. has announced that it would be including Indian Government bonds (IGB) to its benchmark Emerging Market Bond index (EMBI), a much-awaited move towards India’s economic advancements and favors the India’s aim of becoming a USD 5 trillion economy. The bonds will have a maximum weight of 10%, which will be phased in over a period of 10 months starting from June 28, 2024..
India has been one of the preferred investment choices for foreign investors on the equities side. Amid global uncertainties and recessionary trends, Indian equity markets fetched FDI inflow of about USD 46.03 billion during FY2023, as per Department of Promotion of Industry and Internal Trade data. On the debt investments, the foreign inflows were contained at meagre ~2% of the total outstanding Indian government bonds. Limited global participation in Indian debt markets has been mainly due to operational issues like local bond settlement rules, tax complexities and stringent foreign investment policies which resulted in painstaking investing in India as well as low investor confidence in the bond market.
To resolve these issues and attain global recognition, the Government of India introduced Fully Accessible Route (FAR) Government securities in 2020, allowing foreign investors to hold Indian bonds without any restrictions. There are 23 FAR Indian Government bonds having a notional value of USD 336 billion eligible for the inclusion.
With the EMBI having asset under management (AUM) of USD 236 billion (Reuters), post inclusion of GoI bonds, the expected inflow is anywhere between USD 25-USD 30 billion through passive routes. However, active funds have already increased their holdings of eligible bonds to almost USD 12 billion till September 2023 from USD 7.4 billion at the end of 2022 (Clearing Corp. of India data), in anticipation of Indian bonds getting included in the bond index. The impact of foreign flows coming in through debt markets would be significant but not immediate on Indian companies.
Impact on Indian economy
India’s fiscal deficit is expected at around 5.9% of GDP for the year 2023-2024, which will result in government borrowing of INR 15 trillion or USD 181 billion (Reuters). With the passive funds coming, the government would have access to a diversified investor base, lower cost of funding and reduced reliance on domestic institutional investors like banks, mutual funds, insurance companies. Besides, increasing capital flows would ultimately fund the current account deficit.
To understand it better, let’s suppose, an additional USD 30 billion flows to India happen by March 2025 through global bond investors, and assuming the fiscal deficits for 2023-24 remains at estimated levels. This would result in expected government borrowings of INR 15 trillion (USD 181 billions). Therefore, passive flows would fund about 15-17% of the total deficit in 12-18 months period. As such, there would be significant impact on fiscal deficit once the 10% allocation to IGBs is done in the EMBI.
Increasing demand of Rupee-dominated Indian Government Bonds (IGB) would subsequently lead to higher demand of INR among investors, leading to the strengthening of INR. Having said that, rising crude oil prices and US bond yields and the investor’s tendency to move towards safer-heaven economies, has led to significant appreciation is USD relative to other emerging currencies including INR. Therefore, in the short run with funds flowing in gradually, the depreciation of INR relative to USD would curtail but the appreciation expected over the period could be in the range of 0.75-0.80 basis points only.
Among emerging economies, with Russia getting involved into a long war with invasion of Ukraine and the rising fear in China – social-political issues, Taiwan conflict and property bubble, India has emerged as one of preferred destination for foreign investors. Though it is pertinent to note that with increasing global funding exposure, the external market volatilities shall also increase. However, we expect this to be not much of a challenge considering India’s sustainable growth as well as its capabilities to emerge as one of the fastest growing economies, as per IMF Economic forecast for 2023 and a poll of 65 economists conducted by Reuters.
While incremental foreign flows that are expected to come may lead to excess liquidity with banks/investors and hence push inflation, we expect that this will not be a significant concern considering the funds are expected to be deployed for long-term use (eligible bonds to have maturity of at least 2.5 years) and hence would auger in India’s infrastructural growth in becoming USD 5 trillion economy. Nevertheless, any major impact on inflation would require prudent liquidity management from RBI.
Impact on Indian Corporates
- Higher availability of funds is a boost for corporate bonds market.
Till now banks, insurance companies and mutual funds have been the largest buyers of government bonds. With access to foreign markets at relatively lower cost, the funds so available from such domestic investors would be channelized towards corporates growth plans, leading to higher availability of funds for corporates. Indian corporate bond market recorded issuances of USD 100 billion in FY2023 and is expected to rise to USD 8.5-9.0 trillion in FY2024, as per Reuters. Majority of these issuances were from financial services sector (mainly banks and NBFCs). With less than a third of the market being covered by manufacturing, construction/real estate, and services sectors, we see a huge potential in tapping bond market by non-financial players.
Considering India is included in other global indices like FTSE Rusell, Bloomberg Barclays, JP Morgan Government Bond Index etc, the funds available for corporate debt issuers is projected to triple relative to GDP by 2030 (S&P global)
- Lower cost of borrowings for Corporates-
Higher foreign demand for Indian government bonds shall put upward pressure on their prices and lead to lower yields. This can translate into lower borrowing costs for the Indian government when it issues new bonds. As yields of corporate bonds are benchmarked to government bond yields, yields are expected to soften for corporate bonds.
Since, government bonds are considered safe and offer lower yields, investors may seek higher returns in other sectors, including the corporate bond market. This can lead to increased demand for corporate bonds, potentially driving up their prices and lowering yields.
The increasing foreign investor confidence in India’s long-term growth as an emerging economy and inclusion in one of 3 major global emerging bond indexes in coming years shall pave the way for Indian bonds getting included in the other two indexes- Bloomberg Barclays, FTSE Rusell. This is a major milestone towards financial globalization of Indian Bond Market. Besides, the increasing investor confidence & market acceptance, access to funds vital for capital growth, higher equity funds flowing in as Indian assets become attractive, shall support the sovereign credit rating of the economy.