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India's inclusion in JP Morgan's bond index can channel billions of dollars into India. How will the government securities market handle it?
On September 20, 2013, Raghuram Rajan, the Reserve Bank of India Governor at the time, was in a conference call with the media.
The Central Bank had announced its latest monetary policy earlier that day and the Governor, who had taken charge 16 days earlier, was in an expansive mood.
In response to a question from a journalist about opening up the bond market, Rajan said: "There is some talk about bringing India into these bond indexes, what needs to be done.
"We will have conversations with the international index agencies, the entities, some of the investment banks that create these indices.
"Let us see what they require, sometimes they require a pace that we have to examine before we feel comfortable with. But we will have those conversations."
Ten years later, almost to the day, on September 22, 2023, JP Morgan said it would include India in its emerging market debt index.
The US bank will include 23 Indian government bonds into its Government Bond Index-Emerging Markets (GBI-EM) benchmarks from June 2024.
In March last year, Russia was taken out of JP Morgan's fixed income indexes, an action that was taken by many index providers in the aftermath of the invasion of Ukraine.
Welcoming the development, V Anantha Nageswaran, the Chief Economic Advisor, said: "It attests to the confidence that financial market participants and financial markets, in general, have on India's potential and growth prospects and its macroeconomic and fiscal policies."
How big a deal is this?
The excitement in India is understandable. Potentially, this can direct billions of dollars to flow into India, reducing the cost of the government's borrowings and helping with various deficits.
JP Morgan's GBI-EM is benchmarked by global fund houses whose combined pool is estimated to be $236 billion.
That raises hopes of a deluge of dollars flowing into the Indian government securities (G-Secs) market.
Others such as Bloomberg and Barclays could also add India to their indexes, adding to these hopes.
The 23 Indian G-Secs to be added to the index have a notional value of $330 billion.
Their inclusion is to be staggered over 10 months, through to March 2025.
Industry experts say anything between $20 billion and $30 billion could flow in, at least on paper.
There could also be more interest in Indian G-Secs among foreign investors.
The Reserve Bank of India, in 2020, introduced rupee-denominated bonds that had no restrictions on foreign ownership.
JP Morgan's decision builds on the Fully Accessible Route for investments in G-Secs by non-residents being made available to domestic investors.
Earlier this year, sovereign green bonds were added to this pool.
To Madan Sabnavis, Chief Economist at Bank of Baroda (BoB), this is a game-changer that will widen the investor base.
"It will give the desired push by increasing the demand for G-Secs and bring down the cost of capital. Its second-round impact will be felt as favourable yield on these indices will, in turn, attract security-specific interest to the wider investor base," says Sabnavis.
Fitch Ratings says the increase in foreign investment in G-Secs is likely to have other positive effects.
A more diverse investor base could reduce crowding-out risks.
If the government becomes less reliant on financing from domestic financial institutions, it could give them greater leeway to provide credit to the private sector.
It could also stimulate further development of the capital market.
The best part, says Fitch, is that "in theory, increased exposure to foreign investor sentiment around G-Secs could encourage the authorities to pursue policies consistent with macroeconomic stability and fiscal prudence, benefitting the sovereign's credit profile over the longer term."
Capital inflows - whether into equities or G-Secs - will call for better fiscal discipline.
Edgy investors, on the other hand, will result in a flight of capital and erode the rupee's value.
Different colours of G-Secs
The government's "Quarterly Report on Public Debt Management for the quarter April-June 2023" shows that nearly 66.8 per cent of the G-Secs are held by banks and insurance firms.
The huge share of banks is linked to the Statutory Liquidity Ratio: They must invest 19 per cent of their demand and time liabilities in G-Secs as required by regulations.
At one level, this creates a captive market for G-Secs; at another, it affects the fisc quality.
The holding of foreign investors in G-Secs, at 1.6 per cent, looks minuscule in comparison.
This could be because the return to investors, after factoring in forex hedging costs, do not look too attractive.
A BoB note says the impact on papers of different tenures will depend on a host of other factors.
It will be important to see how liquid the papers are after they are added to the index.
Data from The Clearing Corporation of India shows the major concentration of liquidity is in the 2033 G-Sec.
Nearly five years ago, the Securities and Exchange Board of India, the stock markets regulator, said large companies with ratings of AA and above should borrow 25 per cent of their funding from the bond market.
This would reduce their reliance on bank finance and lower their cost of funds.
It would also address state-owned banks' capital concerns (read capitalisation) and provisioning needs (of banks, in general) linked to dud loans.
Then there is the issue of financing the country's infrastructure.
The National Infrastructure Pipeline has envisaged ~111 lakh crore of investments between 2019-20 and 2024-25. All of this cannot come from banks alone.
Prospects for corporate bonds
Will corporate bonds be included in global indexes?
Unlikely. T Rabi Sankar, the Reserve Bank of India Deputy Governor, called attention to the rating profile of issuers in the report, "Corporate Bond Markets in India - Challenges and prospects", dated August 24, 2022.
In 2021-22, ratings were assigned to 1,235 corporate debt securities amounting to ~22.55 lakh crore.
Of these, 278, or 22.5 per cent, were rated AAA, 358 (29 per cent) were rated AA, and 66 issuances (5.3 per cent) were non-investment grade.
Though these numbers are skewed in favour of the highly-rated issuances, the skew is much more pronounced in value terms: 80 per cent of issuances in value were rated AAA and another 15 per cent AA.
"While we can discuss the reasons for this trend, it is clear that the corporate bond market largely meets the needs of highly-rated corporates," Sankar noted.
Clearly, there are miles to go on the bond street. Yet, in this festival season, JP Morgan has provided another firecracker.
Feature Presentation: Aslam Hunani/Rediff.com
