Money from foreign investors has been pouring into the $1 trillion Indian government debt market since August, defying a global rout in bonds as expectations rise that India could finally be added to emerging market indexes compiled by JPMorgan Chase & Co. and others. Inclusion would be a milestone for India, which historically restricted access to foreigners, fearing the vagaries of “hot money.” If it happens, overseas investors would have a new way to put money into a giant economy that offers some of the highest returns in the region, and index providers would be able to rebalance their offerings following the exclusion of Russia this year. If it doesn’t, yields could rise, making it more expensive for India to borrow, and the rupee could suffer further.
1. What’s the back story?
India began liberalizing its economy in the 1990s but does all its borrowing locally with rupee-denominated bonds, partly to avoid the volatility that fickle foreign funds can provoke. But in late 2019, India started working to gain access to bond indexes in a bid to lower its borrowing costs and tout its financial discipline. As Covid-19 was ravaging the economy and the government was borrowing at record levels to fund a multibillion-dollar stimulus package, it opened a swath of its sovereign bond market to overseas investors. Global funds, however, were selling emerging-market assets to hoard dollars. Foreign investors still hold only about $17.8 billion, or 2%, of Indian sovereign debt, against a ceiling of 6%. (In Indonesia, another big emerging market, foreigners own about 14% of sovereign debt.) India’s decision came as Chinese sovereign bonds were being added to global indexes starting in 2019. In the three years since then, foreign ownership of Chinese government bonds rose to almost 11% from 7.6%, though the percentage fell this year amid tough market conditions to 9.8% as of Aug. 30, according to data compiled by Bloomberg.
2. How’s it going?
Progress has been slow. India has been on the watch list to get into FTSE Russell’s emerging market debt index since March 2021. It didn’t make it this year but the provider said dialogue will continue and India will be reassesed in March 2023. JPMorgan last year said India was “on track” to be placed on index watch for its much-bigger global emerging-market bond index. Its next review is due this month. A finance ministry adviser said last year that 99% of the preparatory work had been done. But talks stalled soon thereafter. New Delhi balked at tax changes for foreigners -- including the right to tax capital gains -- that would have facilitated trading of Indian debt on international platforms such as Euroclear. There were also domestic political objections over granting tax exemptions for foreign investors that aren’t available to Indians, and continued worries about volatility -- issues that remain unresolved.
3. Why the optimism now?
Russia’s exclusion from JPMorgan’s emerging markets gauges after the country invaded Ukraine may have added incentives for index compilers to consider filling the gap with Indian debt. India’s inclusion would boost the average yield of the overall index, analysts at Goldman Sachs Group Inc. wrote in August. In addition, Chinese and Indonesian government bonds aren’t on Euroclear either, yet they are part of the JPMorgan index. Most investors in the JPMorgan index either support or don’t object to the inclusion, according to Morgan Stanley. “The exclusion of Russia has made the index more concentrated and unbalanced,” its strategists wrote in early September. “Hence JPMorgan has more incentive to include India even without Euroclear.” Finance Minister Nirmala Sitharaman said Sept. 5 that a conclusion was imminent.
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4. What are the potential benefits?
Index providers and investors would be able to diversify their portfolios and allocate money to a high-yielding market in the world’s fifth-largest economy. For India, it would be an opportunity to tap a larger pool of liquidity to meet growing needs. (The nation is set to borrow a record 14.3 trillion rupee ($175 billion) this fiscal year.) Inclusion could attract inflows of $30 billion to $40 billion in the next fiscal year and drive down the yield curve by 40 to 60 basis points, according to Societe Generale SA. That’s money India needs to finance its current account and fiscal deficits that have widened in the aftermath of the pandemic. The inclusion also could provide some relief for the nation’s battered currency, which has slipped to the weakest on record, by easing balance-of-payments pressure.
5. What about the concerns?
They could still dash the latest plans. India has removed limits on foreign ownership on some bonds and made improvements regarding margin requirements and trade reporting to facilitate inclusion in global indexes. But it has ruled out any changes to tax policies, people familiar with the matter have told Bloomberg News. While an index compiler could proceed anyway, previous discussions fell apart over the government’s demand to retain the right to tax capital gains. The government and central bank also remain concerned that foreign inflows will increase the volatility of local markets. Money managers, meanwhile, point to the Euroclear issue, transaction efficiency and clarity on taxes as remaining hurdles.
6. When would it happen?
Actual inclusion for JPMorgan could happen only next year, but word that it’s coming would give comfort and clarity to investors. Goldman expects the announcement to come in the fourth quarter this year and inclusion in the second or third quarter in 2023. Morgan Stanley sees entry in the third quarter next year, as investors need a long lead time. Both expect India’s weight to be at 10%, the maximum for a country in the index, as opposed to an 8% weight that Russia had before its exclusion.
7. What’s the impact been on markets?
The possibility of index inclusion has supported Indian bonds at a time when US Treasury yields have surged. The yield on 10-year rupee bonds had fallen about 30 basis points to 7.33% in late September after reaching a high for the year in June. In contrast, similar-tenor US yields climbed about 70 basis points during the period. Bond purchases by global funds under the so-called Fully Accessible Route jumped to 42 billion rupees in August, the most since January, after six months of continuous outflows. The buying trend continued in September. Still, bond traders have had their hopes dashed in the past on index inclusion and if it doesn’t happen again, rupee notes may see a sell-off.
(Updates with FTSE Russell decision. A previous version corrected percentage foreign ownership of Indonesian bonds in first answer)
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