In sync with India’s rising stock in the global economy and geopolitics, Indian financial market is about to be truly globalised
The Government of India Bond (G-Sec) is a marker for the economy. The yield of the 10-year G-sec is often reckoned as a benchmark for the interest rate in the economy - the RBI therefore tries hard to prevent any wild fluctuation in its yield. Yield is inversely related to price, and when the price soars due to high demand, the yield naturally falls. This is precisely what happened on 21st September, when the yield of the 10-year G-Sec dropped by 7 basis points (0.07 per cent) to a two-month low of 7.08 per cent, before rising to 7.12 per cent eventually. Simultaneously, the rupee appreciated by 0.3 per cent to Rs 82.25 a dollar.
The trigger was an announcement, through a note dated 21st September, by the American bank JP Morgan Chase that the G-Secs would be included in its globally tracked “Government Bond Index for Emerging Markets Global Diversified (GBI-EMGD)” Index suite. Twenty emerging market economies are presently part of the GBI-EM Global index suite: Brazil, Czech Republic, Chile, China, Colombia, Dominican Republic, Egypt, Hungary, Indonesia, Malaysia, Mexico, Peru, Philippines, Poland, Romania, Serbia, South Africa, Thailand, Turkey and Uruguay; now India will be included from June 2024. The decision marks a key positive development for India to boost its standing in international financial markets.
The inclusion followed intense negotiations of the government of India with investors and banks since 2019 and preparing the ground for inclusion. First, the RBI introduced a Fully Accessible Route (FAR) for investments in G-Secs giving non-resident investors complete access to specified G-Secs in 2020. 23 G-Secs with a combined nominal value of $330 billion are presently index-eligible under the FAR – the criteria being a minimum of 2.5 years of remaining maturity (i.e., maturity falling after December 31, 2026) and a notional $1Bn outstanding against the eligible G-Secs.
Other requirements include adequate trading frequency, easy availability and the absence of capital controls in local markets. India is already present in JP Morgan’s GBI-EM Broad and GBI-EM Broad Diversified Indices. But the GBI-EMGD index is closely followed by most global funds and has a huge $236 billion in assets benchmarked against it. Global managers use the index as a benchmark for investment and inclusion automatically opens the door to foreign capital – this applies to all such indices, major among these are Bloomberg, FTSE Russell and JP Morgan.
Their influence in the financial money market is so overwhelming that no country can ignore them. JP Morgan’s index was launched in the 1990s; it dominates the market for dedicated emerging-market-debt investors, with some $780 billion of potential investments tracking its benchmarks. Foreign investors make allocations of their assets depending on the portfolio weights. India’s inclusion in the Index will be spread over 10 months from June 28, 2024, till March 31, 2025, with an addition of 1 per cent weightage every month up to the maximum threshold of 10 per cent, which is a significant presence in the index. This is expected to attract about $25 billion in investments into India at the rate of 1 per cent of assets every month over 10 months, as investors who track the index rebalance their portfolios. A Goldman Sachs report estimates that “India’s fixed income markets could see inflows upwards of $40 billion” over the inclusion horizon till March 2025. The Indian Rupee will appreciate as a result of the increased inflow, mirroring what happened between 2003 and 2008 due to the surge of capital inflows into India. Apart from giving the index provider – J P Morgan Chase – a scope to diversify their index, especially after Russia’s ejection in the wake of its invasion of Ukraine and also given the slowing economy in China, the inclusion will also give exposure to the world’s fifth largest and the fastest growing major economy to all foreign investors. However it means that the globalised investment rules will now apply to the Indian bond market, and Indian tax policies and macroeconomic stability will need to be carefully managed, as any slip may affect the capital inflow. As the Chief Economic Adviser has said, our fiscal and monetary policies must take cognisance of global expectations. As of now, external borrowing is only a small part of our overall loan portfolio, this may increase over time.
Apart from attracting funds, it would also lower the country's interest rate, or borrowing cost of capital, making it even more attractive for investments. This is because the investments in G-Secs will ease borrowing pressures on the money market by freeing up capital for borrowing by the private borrowers – government borrowing will no longer crowd out private borrowing. This will bring down the cost of capital. Financial institutions today are the biggest buyers of the G-Secs, once foreign investors start buying G0secs, they can lend to the private sector for capital creation to boost income generation and growth. Demand for G-Secs by foreign investors will hike up their prices causing the yield to fall. This will help the government reduce its interest costs, bringing down fiscal deficits and helping the government control inflation as well, as interest, fiscal deficit, inflation and exchange price of the rupee are all interrelated.
JPMorgan is the first major emerging market benchmark provider to include India in its indices for emerging markets. The inclusion of India in the GBI-EMGI will open the door for India’s inclusion in the other two major indices as well - Bloomberg and FTSE Russell – shortly. No major index can ignore India’s rising economic power, as demonstrated by the fact that 73 per cent of the benchmarked investors were in favour of India’s inclusion in JP Morgan’s GBI-EM GD index. India fulfils the criteria for inclusion in the Bloomberg Global Aggregate Index of an investment grade (Baaa3/ BBB) and is already on the watchlist for inclusion in the UK-based FTSE Russel’s Index for Emerging Markets. Inclusion in Bloomberg’s Aggregate index is expected to generate forex inflow of $15-20 billion, with India’s weight ranging from 0.6 per cent to 0.8 per cent. Hopefully, inclusion in JPMorgan’s index will ultimately nudge the credit rating agencies - S&P, Fitch and Moody’s - also to upgrade their assessment of India; currently, they all give India their lowest investment-grade rating. In any case, the Indian economy has outperformed most emerging market economies – the Sensex also has outperformed the stock markets of all its peer countries. A rating upgrade is now overdue.
India is also expected to enter other JPMorgan bond indices—the JADE Global Diversified Index, the JESG GBI-EM Index, and other aggregate suites of local currency indices. Its weightage in the GBI-EMG index is expected to rise to 8.7 per cent. Experts estimate that FPI holdings of outstanding G-secs could double by May 2025 to 3.4 per cent compared to September 2023. India's inclusion will trigger outflows elsewhere, leading to shrinkage of weights for government bonds issued by other countries – JP Morgan estimates that Thailand will be the biggest loser with a 1.65 percentage points loss, followed by South Africa, Poland, Czech Republic and Brazil. The Indian financial market, about to be truly globalised, is at last coming of age, in sync with India’s rising heft in global economy and geopolitics.
(The author, a former Director General at the Office of the Comptroller & Auditor General of India, is currently a Professor at the Arun Jaitley National Institute of Financial Management; views are personal)
