RBI may absorb foreign inflows via bond index inclusion: JP Morgan's Chinoy

The Reserve Bank of India (RBI) will likely absorb all foreign inflows after the inclusion of Indian government bonds into JP Morgan's Government Bond Index-Emerging Markets (GBI-EM), leading to a minimal impact on the rupee-dollar exchange rate, said Sajjid Chinoy, MD and chief India economist at JP Morgan.

"Given past behaviour, the central bank will absorb all these flows. India’s reserves, unlike the rest of Asia, are not earned reserves from current account surpluses; they are borrowed reserves in terms of current account capital flows. So, for every dollar the RBI has, there’s a corresponding liability in the economy’s timeline. My sense is that the impact of the rupee will be minimal,” explained Chinoy.

In 2022, India’s foreign exchange reserves fell sharply following the Russia-Ukraine war, as the central bank actively intervened in the foreign exchange market to curb volatility. However, the central bank rebuilt its reserves in 2023, crossing $600 billion once again. The latest data shows that India’s foreign exchange reserves stood at $617.2 billion in the week ended February 9, down $5.2 billion from the previous week.

Chinoy also highlighted the dynamic relationship between the dollar and the rupee. He noted that when the dollar strengthens, the rupee typically outperforms as the RBI sells dollars. This trend contrasts with many other emerging market currencies. Conversely, when the dollar weakens and other emerging market currencies rebound, the RBI buys back its dollars, leading to rupee depreciation

He said that if there is an anticipation for the dollar to weaken over the next 12-18 months as the Federal Reserve implements rate cuts, it presents an opportunity for India, on a trade-weighted basis, to depreciate and potentially gain value.

JP Morgan has decided to include government papers, issued by the RBI under the Fully Accessible Route (FAR), in its widely tracked GBI-EM. The inclusion process will start in June and will be phased over a 10-month period, with 1 per cent weight included each month until March 31, 2025. Indian bonds will have 10 per cent weight, similar to China.

With $250 billion of assets under management tracking the index, Viquar Shaikh, head of Index Research Asia at JP Morgan, estimates that $25 billion inflows are expected during the period. As per the index inclusion criteria, eligible instruments are required to have a notional outstanding above $1 billion (equivalent) and at least 2.5 years remaining maturity.