Explained: What JP Morgan's bond inclusion means for India, markets, rupee

The move could attract more foreign investments into bonds, strengthen the rupee and improve India's credit rating

India is set to see billions of dollars of inflows after JP Morgan Chase & Co became the first global index provider to include Indian bonds on its emerging market index last week. Currently, foreign investors own two per cent of Indian debt, a number which could more than double after the next inclusion.

Indian bonds are expected to account for ten per cent of the index once included. 

The inclusion would result in index tracking managers allocating money to India, which is expected to be in tens of billions of dollars.

“This could be a push-factor to prompt foreign inflows into India and foreign investors are likely to be more active in the Indian fixed income market," wrote Morgan Stanley in a note.

Experts believe the move is likely to bring down the cost of borrowing for the government, support the Indian rupee and bond markets, improve the country’s credit rating.

What is the inclusion? 

India will be included into the JPM GBI-EM Global Diversified Index as of 28 June 2024. Its ultimate weight will likely reach the 10% cap, which will be scaled in at 1% per month. The inclusion will be phased over 10 months till March 31, 2025.

India’s yield is around the average for the index, but amongst the highest in EM Asia: 

Source: Bloomberg, Goldman Sachs Global Investment Research

Launched in June 2005 as the first comprehensive global local emerging markets index, GBI-EM tracks local currency bonds issued by emerging market governments. It has $213 billion worth of assets under management (AUM).

JP Morgan said India had been on Index Watch Positive since 2021 for inclusion in the GBI-EM, following the government’s introduction of the fully accessible route (FAR) programme in 2020 and substantive market reforms for aiding foreign portfolio investment.

Eligible securities will only be those within the FAR bonds subset, which allows foreign investors to invest in Indian government bonds without restrictions. 

"It is going to be a staggered implementation starting June, 28, 2024, adding 1% weight every month, implying a potential monthly inflow of about $2 billion dollars. It is significant, but not immediate. The impact is positive, mostly for bonds with maturity greater than 5 years, so should lead to further flattening of the curve. While there will be a 10-15 bp rally, we don’t think it will extend beyond that immediately. The shorter end of the curve is anchored by RBI repo rates and tight liquidity conditions," said Sandeep Bagla, CEO Trust Mutual Fund.

India's inclusion would result in more foreign inflows into India

 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), as per a Goldman Sachs analysis.  Given that several emerging market-dedicated funds are already set up in India, Goldman believes the flows will be front-loaded, beginning immediately, as investors pre-position for inclusion next year. 

"We estimate that India’s inclusion could prompt passive inflows of around $30 billion (comprising EM 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) vol perspective, we think it could attract at least another $10 billion of active flows (i.e. overweight positioning, off-index flows by cross-over funds as well as total return positions)," said Goldman Sachs in a note. 

"We estimate this implies direct inflows of USD 20-25 billion over the course of the next 18-21 months, but some front-loading of inflows cannot be discounted," Rahul Bajoria, managing director and head of emerging market Asia (ex-China) at Barclays, said in a note on Friday.

Japanese brokerage Nomura has pegged the inflows at $23.6 billion, which is 10 per cent of the $ 236 billion of asset under management tracking the index.

As many as 23 G-Secs (government securities) with a combined value of $ 330 billion are eligible for inclusion in the global index.

India's inclusion will see outflows elsewhere

India's inclusion will trigger outflows elsewhere, with weightings for domestic government bonds issued by other countries set to shrink: Thailand will see the biggest losses at 1.65 percentage points, while South Africa, Poland, Czech Republic and Brazil will see theirs cut by 1-1.36 percentage points, according to JPMorgan.

Nomura note said Thailand could bear the brunt of the relocation of resources to India with outflows amounting to $3.6 billion.

Move supports the rupee 

Larger debt inflows from next financial year will make it easier for India to finance its current account deficit and reduce the pressure on the rupee.

India's bond market is worth more than $2 trillion. When foreign investors buy Indian bonds included in the index, they exchange their foreign currency, such as dollars, for rupees. The demand for the rupee then increases its value, making it stronger against other currencies. 

 "Beyond the near-term euphoria, this should structurally augur well for rates and FX markets, leading to lower cost of borrowings for the economy at large and more accountable fiscal policy-making," said Madhavi Arora, lead economist at Emkay Global Financial Services.

Indian bonds may also enter other global indexes

The development could mean Indian bonds’ entry into another widely tracked index, the Bloomberg Global Aggregate Index, which could result in inflows of another $15 billion. Typically the review for this index inclusion happens in November, with results being announced in January.

According to Barclays research, India’s prospects for getting into other major bond indices, such as the Bloomberg Global Aggregate Index and the FTSE Russell World Government Bond Index, however, remain low as they need Euroclearability for ease of settlement and a higher sovereign credit rating, which India does not appear close to.

However, India does not meet the credit rating criteria for inclusion in the FTSE WGBI index, which needs ‘A-’ for S&P and ‘A3’ for Moody’s. India has a rating of BBB- by S&P and Baa3 by Moody’s.

What does it mean for bond yields and borrowing cost?

 India's fiscal deficit remains high at a targeted 5.9% of GDP for the year ending March 31, 2024, which will result in the government borrowing a record 15 trillion rupees (about $181 billion). So far, banks, insurance companies and mutual funds have been the largest buyers of government debt. An additional source of funds will help cap bond yields and the government's borrowing costs.

Traders estimate the benchmark bond yield will fall 10-15 basis points to 7% over the next few months. Corporate borrowers will also benefit as their borrowing costs are benchmarked to government bonds. India's fiscal deficit remains high at a targeted 5.9% of GDP for the year ending March 31, 2024, which will result in the government borrowing a record 15 trillion rupees (about $181 billion).

So far, banks, insurance companies and mutual funds have been the largest buyers of government debt. An additional source of funds will help cap bond yields and the government's borrowing costs. However, increased foreign flows will also make the bond and currency markets more volatile and could push the government and central bank to intervene more actively.

" This JP Morgan index is $240 billion. India will be 10% of it, which means $24 billion, and that is huge. This will reset the base rate for India and the yield should come down sharply. India's cost of borrowing will come down. Since COVID-19, the fiscal deficit in India has remained elevated due to higher borrowing. This event will ease borrowing pressure as a large part of the borrowing will be observed by this route. Banks Treasury will be flushed with mark-to-market gains. At the same time, it is a big positive for our currency as a big dollar flow will be there due to the buying of g-sec. As far as the equity market is concerned it is positive for Banks, NBFC, leveraged companies etc By and large it is a big macro positive for India," said Mukesh Kochar, National Head - Wealth, AUM Capital.

Accrual funds have become more attractive

 Yield on the benchmark 10-year G-Sec, was trading in a narrow range at around 7.15%. Post the global bond index inclusion news flow, yield fell below 7.10%.
 

"Accrual remains the theme for 2023 on a risk-reward basis. The yield curve in the 2 –5 years segment is offering attractive nominal yields; given that we have seen some correction in longer end bonds one can look to play duration in this segment on a tactical basis," said Sachin Jain, analyst at ICICI Securities.

 

Index inclusion opens up India's fiscal situation to greater scrutiny

At 8.9% of gross domestic product, India’s combined government fiscal deficit is the highest among the 20 countries tracked under the JPMorgan Government Bond Index-Emerging Markets.

Global investors will pay attention to efforts by Prime Minister Narendra Modi’s government to reduce its deficit and debt, said Kotak Securities economists led by Suvodeep Rakshit.

“The index inclusion opens up India’s fiscal situation to greater scrutiny, with spending quality, efficiency of tax and other receipts collection, and adherence to fiscal consolidation path being closely monitored,” they said.

Inflows into India’s government debt market could make the economy more dependent on global financial conditions, adding to volatility, said Pranjul Bhandari, an economist with HSBC Holdings. “Strong institutions-backed, rules-based policy making will become even more critical in such times,” she said. 

With inputs from Agencies