What is holding India back from joining global bond indices?

India recently overtook the UK to become the fifth largest economy of the world. And it is on track to clinch the third spot by 2030. The recent global headwinds failed to dent its economy even as several big powers are staring at recession.

India is now the fifth biggest equity market as well. The country’s $1 trillion sovereign bond market is one of the largest among emerging-market economies. But, notwithstanding all these achievements, the country is still out of global bond indexes.

The talks between the Central government and index holders have been on for long, but without a result. But, now, there is a renewed push from global investors for India’s inclusion.

Like equities, which have several global indices like MSCI index, bonds too have global indices that track the bond markets in multiple countries. These indices serve as key indicators to global investors for making investment decisions.

JP Morgan and Bloomberg-Barclay’s are some of the major indices in debt markets that provide a wide range of indices from emerging markets to country specific to world indices. However, getting included in these indices that are managed by financial firms or index holders is not easy. There is a strict criteria that has to be met.

Several factors hindered India’s inclusion so far. One of the biggest concerns among investors over the years was accessibility. To allay such concerns, the Reserve Bank of India introduced a fully accessible route (FAR) in 2020, under which foreign investors and institutions can invest in Indian bonds without any restrictions and investment caps. There were also concerns around settlement, where bond indices insist on Euroclear option.

Ajay Manglunia, MD and head of Investment Grade Group, JM Financial says tech concessions to global investors and global settlement were some of the major hurdles. There is a push from the global investors for India's inclusion.

There were expectations from the Budget this year that the government would announce tax breaks for foreign investors, but that didn't happen. In last year’s index review, India was also put on watch list for JP Morgan’s emerging market index, but the global house had said India needs to improve market access, trading and settlement to achieve index inclusion.

Global index provider FTSE Russell too placed Indian bonds on a watchlist for possible inclusion in its emerging market debt index in 2021 but later said the status remained unchanged.

There was always a market consensus that India’s inclusion would happen given the scale of India’s debt market and growing economic clout. But, for long, the question of when remained.

The chorus of India's inclusion in global bond indices has only grown stronger recently. In a shift from earlier stance, global bond index providers have been reaching out to India for the inclusion on their platforms, according to a Business Standard report. Financial Times reported that JP Morgan has sought views of investors on India's inclusion. Joining the bandwagon, Morgan Stanley recently said that India might get included in JP Morgan's emerging market bond index. The announcement could come as early as this month or sometime next month, according to the house.

Another bank Goldman Sachs also foresaw India’s inclusion but in the second or third quarter next year. Russia’s exclusion from the JP Morgan bond index after the invasion of Ukraine has made the index more concentrated and unbalanced, boosting India's chances. Now that the inclusion seems more likely, government officials are also exploring ways to facilitate settlements locally. The index providers have reportedly agreed to try and facilitate the process without pressing for tax exemptions, a key hurdle that has hindered India's inclusion so far.

Foreign funds have invested $538 million in Indian bonds in August amid the index inclusion buzz, after six months of continuous outflows.
 

India’s bond yields have also come down from highs on the buzz of India’s inclusion in the JP Morgan bond index. The 10-year benchmark yield was at 7.13% as of Wednesday morning.

India's inclusion in the indices could prove to be a game changer in terms of foreign flows.

Analysts expect inflows to the tune of $30 billion in the next fiscal alone, from the current $18 billion.

Morgan Stanley said bond investors could position themselves before the actual inclusion, which could drive the rally for one or two months in advance, given a prospective $3 billion inflow every month. The actual inflows could take nine to 12 months and will be seen only in June or September 2023. The fund house last year said it expects $170 billion in bond flows over the next decade, lifting Indian bond prices while lowering borrowing costs. This would push foreign ownership in Indian bonds, currently less than 2%, to 9% by 2031.

Pankaj Pathak, fund manager - fixed income, Quantum AMC says FPIs could bring a diverse pool of investor base into the bond market. In the short run, sceptical about the current momentum. Passive flows into Indian bonds will take some time. 

As more foreign capital flows into Indian government bonds, India's consolidated deficit could shrink in the longer run and the inclusion will help Indian corporations with their capital needs and it bodes well for the overall economy.