Is India inching closer to inclusion in the Global Bond Index?

Higher than expected domestic inflation is causing a section of the market to believe that we could possibly be at the bottom of the interest rate cycle. The Overnight Index Swap (OIS) markets are beginning to price out any further accommodation. Despite the sentiment in the bond index turning around post the Monetary Policy Committee (MPC) leaving rates unchanged and after partial devolvement of benchmark security on primary dealers (PDs), the Reserve Bank of India (RBI) has refrained from announcing an open market operation (OMO) so far.


 

The nervousness in the bond markets on account of higher inflation, larger supply of bonds in H2 and absence of RBI OMOs so far is evident. The 10-yr yields are now at 6 per cent. At the same time, RBI continues to aggressively mop up inflows in the forex (FX) market, thereby preventing the Rupee from appreciating, contrary to the broad global USD weakness theme.
 

A hypothesis linking its reaction in FX and bond markets is that India could possibly be closer to inclusion in a global bond index and that it could happen in FY21 itself. Inclusion in a bond index could result in inflow to the tune of $20 billion to $30 billion. This would mean the RBI would have to do fewer OMOs.

 
The Global Bond Index includes investment-grade and government bonds from around the world with maturities greater than one year. The Index is a market-weighted index of global government, government-related agencies, corporate and securitised fixed income investments with maturities greater than one year.


 
That said, aggressive FX purchases now would ensure that the Rupee appreciation on account of those flows would simply align USD/INR with the Dollar index, thereby preventing the Rupee from strengthening too much and resulting in Dutch Disease.
 
A steeper term structure in the absence of OMOs would also leave something on the table for foreign portfolio investors (FPIs) and make Indian bonds attractive. Also higher FX reserves would help retain FPI interest as it would offer a good carry amidst low volatility.

 
Of course, the other hypothesis could be:
 
 1) The RBI is just shoring up its Reserves to keep the Rupee weak in relative terms amid broad USD weakness to aid exports and the domestic manufacturing sector.
 
2) The RBI is looking to shore up its economic capital in line with the Jalan Committee report; and
 
3) RBI is building up a cushion against a possible Rating downgrade.
 
However, considering the belligerent Reserve accumulation and the extreme intolerance the RBI has exhibited towards Rupee appreciation, the inclusion hypothesis seems plausible.
 

 
The author is CEO of IFA Global. Views are his own.