Is India's Inclusion in JP Morgan's Bond Index Just a Good Market Sentiment? The inclusion of the IGBs will be staggered over a 10-month period starting June, 2024, through March, 2025 (i.e., inclusion of 1% weight per month).
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From June 28, 2024, Indian Government Bonds (IGB) will be included in JP Morgan's GBI-EM Global index. The inclusion will be staggered over a 10-month period starting June, 2024, through March, 2025 (i.e., inclusion of 1% weight per month). In addition, IGBs will also be included in smaller JPM indices (like JADE Global Diversified Index). A total of 23 Indian Government Bonds (IGBs) with a combined notional value of $330 billion have been identified for the index inclusion.
What is noteworthy is that GBI-EM GD accounts for US$ 213 billion of the estimated US$ 236 billion benchmarked to the GBI-EM family of indices. While the news evoked much euphoria as the development is likely to infuse $20-25 bn flows into IGBs, the big question is: will it have any material impact on the economy? The opinions are divided.
Impact on bond yields and investments
The move is seen having a significant impact on bond yields and investment. Says Arihant Bardia, CIO and Founder, Valtrust, "The inflow into Indian Gsec market is expected to have significant impact on bond yields. Indian 10-year Gsec yields are expected to fall further. This also makes Target Maturity Funds (TMFs) with G-Secs as a compelling instrument, despite removal of indexation benefit from the debt funds. The unique combination of predictability, tax efficiency, and liquidity offered by Target Maturity funds make them an ideal choice for those with a longer investment horizon."
"As rates are headed lower in the long run, these funds give the opportunity to investors to lock in the high rates for a period of 10-25 years, depending on the investors' appetite," Bardia adds.
Agrees Shantanu Bhargava, Managing Director, Head of Discretionary Investment Services, Waterfield Advisors, "This has been a long-awaited measure and could be a significant boost for Indian debt markets. It could act as a catalyst for much-needed bond market deepening. In the medium to long term, enhanced foreign participation could result in reduced yields on government bonds. That, in turn, may gradually (medium/long term) reduce the yields on corporate bonds too, resulting in reduction in cost of capital & cost of borrowing over the long-term."
Spread between India and the US
However, ASK Wealth Advisors takes a contrarian view in its recent research note and says there will no material impact on bond yields, and the determining factor for that will be global, especially US policy rates.
"Total stock of outstanding IGBs today is around 100 lakh crores, or $1.2 trillion. A flow of $20-25 bn is a veritable drop in the ocean on this stock. Let us look at flow. Assuming a 10-12% growth in nominal fiscal deficit for FY2025 (when these flows are expected to materialize), government will issue IGBs worth INR 17 lakh crores in that year. the expected flow of $20 bn, or INR 1.65 lac crores, will be less than 10% of the gross borrowing for the year. Above all, this flow is only a one-off adjustment to index weights. Ongoing flows – and markets discount ongoing expectations rather than one-offs – are going to be lot lesser, dependent on investor flows into EM bond funds benchmarked to JPM GBI-EM GD Index. Markets price investments basis expectations of ongoing changes, not one-offs. Given the uncertain (And small) nature of the former, yields are unlikely to move materially," it reads.
The note also said that India's monetary tightening has been remarkably mild, in the face of sharp increases in global tightening, especially US Fed. As a result, the spread between Indian and US 10-year yields are at all-time lows. This denotes a richly valued asset class for foreigners, not a relative value opportunity. While passive funds will still invest – they have no choice, active investors are unlikely to find massive opportunity in India risk-adjusted spreads to merit large incremental allocations.
Will it bolster rupee?
The rupee has experienced an average annualized depreciation of 3-3.5% against the US dollar over a slightly extended period. According to market experts, the move will bring confidence in the rupee. Says Alok Agarwal, Portfolio Manager, Alchemy Capital Management, "Now, with the introduction of a consistent source of inflow, depending on the inclusion of specific indices, there is the potential for increased stability and confidence in the rupee. Consequently, India would become an even more appealing destination for equity investment, as the currency would favour foreign investors. This could lead to further inflows into the equity markets, with the hope of mitigating the depreciation witnessed in the past.
"Additionally, the inclusion of India in these prestigious indices will help stabilize the Indian Rupee. As global investors flock to our bond market, it will add an element of stability to our currency, ensuring its strength in the global financial landscape".
INR gain vs. DM currencies barring USD
According to ASK Wealth, the move may provide some more support to INR, but the latter has anyway been doing quite well. "While its depreciated against the super-hot USD, it has appreciated against most Developed Market (DM) currencies. Outlook for INR is also positive, with 1 year forward spreads – the USD/INR price at which someone can lock in the price of USD 1 year hence – is at near-record lows (2%). Again, $20 bn one-off is nice to have, but there isn't really a need for a one-time confidence capital right now. INR outlook, therefore, doesn't really change."