Bonds on watch

Inclusion in global indices would demand higher fiscal standards

The Indian government securities could be included in the FTSE Russell Emerging Markets Government Bond Index (EMGBI). This would encourage the entry of fresh overseas funds at a time when the government is borrowing huge sums to bridge the fiscal deficit. The inclusion in a major global index will also impact the exchange rate and the yield curve of Indian bonds. It may help to deepen the illiquid secondary market for bonds, as well. FTSE Russell, a subsidiary of the London Stock Exchange Group, maintains many globally benchmarked equity and fixed income indices. On Monday, in its semi-annual country classification for fixed income and equities, the financial service provider revealed India, along with Saudi Arabia, had been placed on the watchlist for inclusion into the EMGBI. The next update to this index is due in September 2021.

As and when India makes the cut for inclusion, it would automatically ensure interest in rupee treasuries from a new set of foreign portfolio investors (FPI) which hold portfolios tracking the EMGBI, or use that index as a portfolio benchmark. Ballpark estimates suggest a market of India’s size could easily attract $10 billion of inflows in the first year of inclusion and larger inflows over time. Higher government borrowing is pushing up yields in the bond market. On their part, FPIs are expected to abide by investment limits in Indian debt calculated as a percentage of the aggregated outstanding stocks of government debt. The limits for 2020-21 were set at 6 per cent and 2 per cent, respectively, of the outstanding stock of government securities and state development loans. This would amount to roughly Rs 9.5 trillion. The FPIs are currently well under the limit, which increases in absolute terms as new bonds are issued. Indeed, FPIs have been consistent sellers of rupee debt in the past three fiscal years. They were last net buyers in 2017-18, to the tune of Rs 1.19 trillion. In 2020-21 (till March 20, 2021), FPIs sold bonds worth Rs 51,221 crore on top of Rs 48,710 crore in 2019-20.

The inclusion in the EMGBI would be debated by the FTSE Country Classification Advisory Committee, which consists of market practitioners with technical expertise and local knowledge. The committee considers the advisability of inclusion by the assessment of parameters such as “quality of market” (including regulation, dealing landscape, custody and settlement norms, existence of derivatives markets, etc.), “materiality” (size of market), consistency and predictability, cost limitations, stability, market access, and so on. India should qualify on most counts. Inflows would be welcome, given that government finances are under pressure. It would help reduce yields and borrowing cost in general. If such inflows help to deepen the extremely illiquid secondary market, all the better. Besides, this is likely to be long-term money.

However, if there are higher FPI inflows, the Reserve Bank of India will have to work hard to keep the rupee stable at a reasonable level. Currency swings could impact FPI attitudes along with trade balance. Increased dependence on foreign flows would also mean that the government will have to adhere to higher fiscal standards. A large reversal at a later date because of a change in outlook could create financial stability risks. Thus, the government will need to ensure that such risks are minimised.