Global bond index providers reach out to India amid geopolitical shifts

Recent rally in bonds despite US bond selloff signals optimism on global index inclusion

In a departure from earlier instances, global bond index providers have been reaching out to India for the inclusion of its sovereign debt on their platforms, as the growing exclusion of Russia from international capital markets has led to the need to draw in a large emerging market economy.

Not only have global index providers themselves restarted the discussions, but have also agreed to try and facilitate the process without pressing for tax exemptions for overseas investors–the key sticking point in earlier rounds of talks.

Moreover, if India’s bonds are included in a global index, the process would be facilitated without having to go through the Belgium-based Euroclear trading platform. Access to the Euroclear platform, which would require tax concessions, was another hurdle to the process achieving fruition.

According to the latest RBI data, the total outstanding stock of government securities is currently worth Rs 86.12 trillion (roughly $1 trillion). This makes the market twice the size of Mexico’s bond market and thrice Indonesia's.

“In February or March, when talks concluded between the index providers, the finance ministry and RBI, a couple of controversial points discussed were Euroclear and taxability etc. The government was not willing to compromise on taxation and that’s why India’s index inclusion did not happen,” a senior treasury official said.

“But post-March, after the Ukraine war, Russia is now completely out of the index with sanctions having been imposed on it. This time around, it’s the index guys who have approached the finance ministry saying the file should be re-opened to see how it can be done. That’s why the optimism is much more because people know that the index guys have come and approached so the probability of them now accepting what the government is saying is higher,” he said.

Mid-August onwards, speculation of Indian government bonds being included on a global index has been growing as several international financial powerhouses, including Goldman Sachs and Morgan Stanley, have expressed optimism about the process.

In an August 16 note, Goldman Sachs said it expects domestic government bonds to be included in the GBI-EM Global Diversified bond index in 2023, a move that would bring in about $30 billion of flows in a year. For this to happen, an announcement would need to be made late September which is when the reconstitution of global indices occurs.

Subsequently, the Financial Times reported that progress had been made on listing India’s bonds in the JP Morgan bond index.

Since August 16, yield on the 10-year benchmark government bond has declined 21 basis points despite hardening US Treasury yields, which typically dissuade overseas investors from deploying funds in emerging market assets. Yield on the 10-year US Treasury note has climbed a whopping 53 basis points over the same period.

Bond prices fall when yields rise and vice-versa.

For India, the prospect of durable flows of the nature that emanate from inclusion in a global bond index is a welcome one, given that the size of the government’s borrowing has grown exponentially, while the pool of investors has largely remained stable. Steady overseas investment in debt would also reduce the pressure on the government to finance the fiscal deficit.

 “The JPM EM Bond index is known as a 1-10 index  - the maximum exposure that a country can have is 10 per cent and min of 1 per cent. So India once included will definitely be 10 per cent but it may be a gradual increase of one per cent per month over 10 months (like it was when China was included),” Arihant Bardia, co-founder at Valtrust said.

“However if reconstituted then hedge funds will front run the investment and may not wait till the index reaches 10 per cent holding. In fact the recent rally on 10-year g-sec is purely on account of this. In case inclusion does not happen the reversal will be sharp to around 7.5 per cent,” he said.

Amid the optimism, however, there are still reasons for caution. At the current stage of talks, it is incumbent on investors to agree to sign up in a framework that is outside of the ease provided by the Euroclear platform.

Some traders cited time-consuming know-your-customer norms and navigating different time zones as challenges to the process. While China and Indonesia do have their bonds listed on global indexes outside of the Euroclear platform, traders said that many operational hurdles had been overcome in those countries.

“It’s up to the investors and the index to either accept India or not accept India and from what we are hearing, it looks like a close call,” another treasury official said.

Inclusion in a global bond index also exerts pressure on the government to adhere to fiscal discipline and ensure that its bonds retain investment grade. At present, while India’s bonds are of investment grade, they are one notch above a junk rating.