India's inclusion in the bond index will increase investor vigilance

By Andy Mukherjee

The bond market is so often portrayed as a vigilante on the prowl that it’s easy to miss those rare occasions when the nemesis becomes a friend. India is experiencing one such moment. Global debt investors are coming to its aid after a tumultuous couple of weeks in which the most-populous nation’s relationship with the rest of the world has been on a rollercoaster ride. 
 

At first, things were triumphant. As the host of a successful Group of 20 summit, Prime Minister Narendra Modi stitched up deals with the West and unveiled the blueprint for a rail and shipping corridor connecting India with the Middle East and Europe: a new silk route of world trade.

But the mood didn’t take long to sour. Canadian Prime Minister Justin Trudeau went back home and accused the Indian government of masterminding the killing of a Sikh leader in his country. Although New Delhi has rejected the allegation, the stakes are high. With US Secretary of State Antony Blinken urging the Modi administration to cooperate with Canada’s investigation, a failure to deescalate diplomatic tensions may alienate India from the Group of Seven rich nations, something neither side wants.

Also Read: India to enter JP Morgan's EM bond index; set for $20 billion inflow

Enter JPMorgan Chase & Co. The bank said Thursday that it would add Indian government debt to its emerging-market index. Inclusion in global bond gauges is something mandarins in New Delhi have long craved. For the fast-growing economy that typically runs a current-account deficit, the decision opens the door to as much as 10% of the $236 billion of assets at funds that follow the key benchmark and its smaller offshoots. That’s $24 billion of inflows over 10 months starting in June 2024. Enhanced access to external resources means an opportunity to pursue higher growth. However, credibility — something investors will watch closely — may very much remain India’s Achilles’ heel.

Mending the diplomatic fences is the most urgent item on the to-do list. The West hopes to have the world’s biggest democracy as its ally. While it is perfectly legitimate for a large nation to emphasize its own interests in tactical calculations (such as whether to buy oil from Russia), strategically India must remain an acceptable partner. It has much to gain from stepping into the breach of deteriorating US-China relations. For Modi to pursue an isolationist course — just to buttress his stature as a macho, nationalist leader among his Hindu right-wing supporters — would go against the international statesman image he worked hard to project during India’s soon-to-conclude G20 presidency.

The credibility gap is not limited to Modi’s perception abroad, or how his majoritarian politics may lead to sharper religious polarization at home ahead of next year’s general elections. In recent years, the country’s institutional structure for record-keeping has taken some serious blows to its reputation. The finance ministry is currently engaged in a war of words with a former chief economic adviser who suspects that reported gross domestic product growth of 7.8% in the June quarter was inflated because wrong price indexes were used to deflate nominal output.  

Also Read: JPMorgan to add India to its emerging-markets bond index in June 2024

One could point to China’s notoriety for unreliable data to say that it’s a non-issue for global investors. However, the People’s Republic has excess domestic savings and a current account that’s perennially in surplus. India is the opposite. Greater exposure to global fund flows brings with it the threat of more abrupt reversals. It is imperative for the country to shore up the trustworthiness of its statistics. Similarly, the government’s auditor has pointed to numerous holes in its financial reporting. These, too, need to be filled. Sooner rather than later.

At the end of 2022, foreigners owned a little more than $7 billion of bonds that have now become eligible for index inclusion. That figure has gone up this year in anticipation of the move, and will increase further before the formal entry into JPMorgan’s benchmark. And this is just the beginning. FTSE Russell has the nation’s bonds on watch for inclusion in its emerging-market gauge. Similarly, a possible weighting of 0.6%-0.7% in the Bloomberg Global Aggregate Index could lead to anywhere between $12 billion and $14 billion in inflows, HSBC Group Holdings Plc economists estimate. (Bloomberg Opinion and Bloomberg Index Services Ltd. are both owned by Bloomberg LP.) 

Given the large increase in financial flows, the credibility of the central bank needs attention. A new book by former Indian Finance Secretary Subhash Chandra Garg shows how relations between Reserve Bank of India Governor Urjit Patel and the government had completely broken down ahead of his abrupt resignation in December 2018. Modi found Patel unreceptive to the idea of putting RBI’s accumulated reserves to use. In a heated meeting, the prime minister likened the central bank chief to a “snake who sits over a hoard of money,” Garg wrote in We Also Make Policy: An Insider's Account of How the Finance Ministry Functions. 

Back then, the question of whether the RBI had excess capital and could return some of it to the government  went to experts. They framed new rules and averted a disaster. But as the economy comes to rely more on foreign capital, any unilateral attempt by politicians to mount a raid on the RBI’s reserves could have serious consequences.

The RBI’s capital is a vital component of the sovereign’s creditworthiness, and Team Modi has assiduously lobbied rating firms for an upgrade. Moody’s Investors Service refused to oblige last month when it affirmed the country’s foreign-currency debt at Baa3, the last rung of investment grade. Meanwhile, household savings are at a 16-year low. Given all that, New Delhi should be happy that foreign funds will soon be big buyers of its rupee-denominated debt: Help has arrived just when it’s needed. Still, it’s worth remembering that bond vigilantes are real. Investors can be highly unforgiving of borrowers who don’t play by the rules. India should know better than to risk making an enemy of its new friend. 
Disclaimer: This is a Bloomberg Opinion piece, and these are the personal opinions of the writer. They do not reflect the views of www.business-standard.com or the Business Standard newspaper