Unlocking the Potential: Indian Government Bonds in J.P. Morgan’s EM Index
Could this be a game changer for the Indian Economy? The index inclusion is expected to attract capital inflows estimated at $22 billion to $30 billion into India’s debt market!
In September, JPMorgan Chase & Co. said it would add Indian government bonds to its benchmark emerging-market index from June 2024. This is a keenly awaited event that has the potential to drive billions of foreign inflows into India’s debt market. It demonstrates India’s increasing appeal to foreign investors as the country’s economic growth outstrips its peers and its geopolitical influence grows.
This article discusses the inclusion of Indian Government Bonds in the J.P. Morgan Emerging Markets Government Bond Index; and factors that might have led to it.
Let’s try to understand what these factors mean and how we can interpret them using economic measures.
Introduction
In a significant development for India's financial markets and the global investment landscape, Indian government bonds are set to be included in the prestigious and widely tracked J.P. Morgan Government Bond Index-Emerging Markets (GBI-EM), a standard for local EM benchmarks.
This strategic move comes at a time when India is rapidly becoming a hotspot for foreign investments and as international investors increasingly look beyond traditional markets.
Which Indian bonds will be included and at what weight?
The index, launched in 2005 and is currently benchmarked by about $236 billion in global funds. J.P. Morgan’s GBI-EM index is speculated to have 23 Indian Government Bonds (IGBs) with a notional value of $330 billion, which are expected to attain a peak weight of 10 percent in the index. This addition will occur gradually over a ten-month period, spanning from June 28, 2024, to March 31, 2025, with a monthly inclusion rate of 1 percent. India's weight is expected to reach the maximum weight threshold of 10% in the GBI-EM Global Diversified (JPMGBIEMGD), and approximately 8.7% in the GBI-EM Global index4.
What factors led to the inclusion?
India initiated discussions about the potential inclusion of its debt in global indexes in 2019. However, the government's position on other matters, such as capital gains taxes and local settlement, caused a delay in its inclusion, despite it maintaining a steadfast stance4.
From the index point of view, several factors have converged to propel Indian government bonds into the spotlight, including a surge in Foreign Direct Investment (FDI) flows, the introduction of the 'Fully Accessible Route (FAR)' by India in March 2020, the exclusion of Russia from the index, and the weakening of China's position, among other reasons.
Let’s explore some of the motivations behind India's inclusion in the GBI-EM and what it means for India's financial future.
All charts are generated using Python.
You can access my Python notebook and datasets here: https://github.com/HiteekshaMathurGhai/Economic-metrics-for-India
Data is sourced from links mentioned below the images
Introduction of 'Fully Accessible Route (FAR)'
One of the critical milestones that paved the way for the inclusion of Indian government bonds in the JP Morgan Emerging Markets Bond Index was the 'Fully Accessible Route (FAR)' introduced by the Indian government in March 2020. The Reserve Bank of India introduced a group of securities that were granted exemption from any foreign investment restrictions, allowing them to be included in global indexes via the 'fully accessible route' (FAR)."
This groundbreaking initiative allows foreign investors to trade Indian government securities without restrictions, thus opening up a vast new opportunity for global investors to participate in India's bond markets. This move not only aligns with India's commitment to economic reforms but also significantly enhances the liquidity and attractiveness of Indian bonds on the global stage.
Due to India's competitive bid-offer spread in Fully Accessible Route (FAR) securities, particularly in contrast to the current constituents of the Emerging Market (EM) index, and the extensive availability of FAR securities amounting to $380 billion, which are currently underinvested by Foreign Portfolio Investors (FPIs), there is a significant potential for substantial FPI inflows.
Fun Fact: The 23 IGBs being included in the index are all from ‘FAR’!
Interpreting this news excerpt
The inclusion of Indian Government Bonds in the index is likely to have positive impacts:
“Structurally, this will lower India’s cost of funding; enhance the liquidity and ownership base of G-Secs (Government Securities), and help India finance its fiscal and CAD. This will also imply more accountable fiscal policy-making ahead,” said Madhavi Arora, Chief Economist, Emkay Global Financial Services.
The inclusion is further expected to provide relief to India’s current account deficit, currently under stress due to rising oil prices in the international market, by channeling fresh flows in the debt market at reduced cost3.
I created a chart with India’s FDI Inflows and current account to visually interpret the impact of the inflows on the current account. Although the FDI inflows will not have a significant impact on the current account, it might fuel a surplus or reduce a deficit slightly. As visible in the red circles, with an increase in FDI inflows, we see an increase (reduction) in the current account surplus (deficit), and vice versa. The inclusion of IGBs in the index is going to increase FDI inflow and consequently provide relief to India’s current account deficit.
Figure 1: Graph showing India’s current account and FDI inflow (Data Source: https://stats.oecd.org)
The Rise of India in Global Investments
India has been on the radar of international investors for a while now. A burgeoning economy, an ever-expanding consumer base, and an increasingly business-friendly environment have made India a favored destination for FDI. The Indian government's efforts to streamline investment regulations and enhance transparency have significantly boosted investor confidence. FDI flows into India have surged, indicating a vote of confidence in the country's economic growth prospects. Based on IMF projections, India's economy is anticipated to become the third-largest in the world by 2027, surpassing Japan and Germany, as its GDP exceeds $5 trillion. India's long-term goal is to achieve developed economy status by 2047.
India’s FDI (foreign direct investment) Debt flows
The chart depicts the remarkable growth in FDI inflows into India. It's evident that FDI has consistently increased over the past years, reaching record levels. This trend suggests a strong vote of confidence from international investors, making India an attractive investment destination. The foreign investments have also had impacts due to positive sentiment as well as the ‘FAR’ described earlier (Q2 2020)
Debt Inflows are gradually picking up again and are expected to rise further in 2024, with a reduction in the outward flow
.
Figure 2: Graph showing India’s FDI Debt flow (Data Source: https://stats.oecd.org)
Interpreting the flows using Yield Differentials (example: Q4-2019 to Q1-2020)
We saw a high inflow around Q4 of 2019 above, and below is a chart depicting the 10y government bond yields of India and the US, with a higher differential towards the end of 2019, making the bond markets in India very attractive at the time and spurring foreign direct investments in Indian debt. This chart can visually demonstrate the competitive advantage of Indian government bonds in terms of yield. This higher yield can act as a significant pull factor for international investors looking to diversify their portfolios and seek better returns.
There may be other factors contributing to the increase/decrease in FDI Debt inflow, but a visual representation of yields is one way of interpreting how bond markets of a particular country are placed!
Figure 3: Graph showing India/US 10yr Treasury yields (Data Source: https://fred.stlouisfed.org/)
Long-term EM Rates
Comparing India’s long-term rates with other emerging market countries also depicts the attractiveness of the bond markets. India’s long-term yields make Indian bond markets more desirable from an investment perspective, in comparison with other EM countries. This can serve as an important backdrop for understanding the factors contributing to India's inclusion in the JP Morgan Emerging Markets Bond Index.
Figure 4: Graph showing long-term interest rates of Emerging Markets (Data Source: https://data.oecd.org/)
Exclusion of Russia
The exclusion of Russia from the JP Morgan Emerging Markets Bond Index has also been a pivotal moment in the evolution of emerging market bonds. This change created a vacancy that various emerging markets, including India, were keen to fill. The move reflected the ongoing geopolitical shifts and the desire of international investors to diversify their portfolios away from regions facing economic and political uncertainties.
Weakening of China's Position
China's growing influence in the global bond market has been undeniable in recent years. However, geopolitical tensions and concerns about China's regulatory environment have led to investor skepticism. This, coupled with a desire for diversification, has prompted investors to explore alternatives.
What does the inclusion mean for India?
Inclusion in the JP Morgan Emerging Markets Bond Index is not just symbolic; it signifies the confidence that global investors have in the Indian economy and its financial markets. As Indian government bonds become part of a globally recognized index, it is expected to attract more international investment, enhance liquidity, and lower borrowing costs for the Indian government. Moreover, this move will likely pave the way for India's corporate bonds to be included in the index in the future.
According to expert options, over the medium to long term, increased foreign involvement could potentially lead to a gradual decline in yields on corporate bonds as well; and the rupee is also expected to gain value.
Conclusion
There have been mixed views about the scale of impact that the inclusion will have on the Indian markets/ ratings at large. The addition of IGBs into the index is likely to create about $25 billion of passive inflows, which is not an exceedingly significant amount in the ~$1.2 trillion outstanding value. Fitch Ratings also mentioned: “We expect the positive effect on the sovereign rating of India’s inclusion in the (GBI-EM) to be small, especially in the near term, as its impact on fiscal credit metrics is unlikely to be significant” 2.
Nevertheless, India's inclusion in the JP Morgan Emerging Markets Bond Index is a testament to its economic resilience, pro-business policies, and global appeal as an investment destination. It is a milestone that sets the stage for greater integration of India into the global financial ecosystem and presents new opportunities for international investors. As India continues to open its doors to the world, its ascent on the global financial stage is poised to accelerate, benefitting both the nation and the global investment community.
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