Bond with Bharat: What activation of J P Morgan Index means for India Inc

While inflows into G-Secs is a given, the secondary effects of these in the corporate bond market are to be watched for

“The inclusion of government bonds in the J P Morgan Bond Index is a vote of confidence about the Indian economy and financial markets,” said Reserve Bank of India Governor (RBI) Shaktikanta Das at the Business Standard BFSI Insight Summit on October 31, 2023 in Mumbai. Come June, and the Index will be activated with 23 Government of India securities or G-Secs. It could result in portfolio inflows of at least $18-22 billion through June-March FY25. (Bloomberg has also launched consultation to do the same in its Emerging Market Indices from September 2024).

Last Thursday, Mint Road did not cut its key rates after its Monetary Policy Committee meeting, but speculation is rife that the second half of this financial year may see southward movement. Read together with the Centre’s lower net-borrowing at Rs 11.75 trillion in FY25, down from Rs 11.80 trillion in FY24, they are major positives for liquidity, demand for G-Secs and the corporate bond market. The latter is critical for India Inc and is anyway up more than 50 per cent over the past five years at Rs 44 trillion (as of end of September 2023). And right after the J P Morgan Bond Index comes alive, there will be a full-fledged Budget when a new government is sworn in following the general elections this summer.

According to Pankaj Pathak, fund manager - fixed income at Quantum AMC, G-Secs are grossly under-owned by foreign investors with less than 2 per cent of the total outstanding. J P Morgan’s indices are benchmarked by approximately $236 billion of global funds. “It seems reasonable to expect $20-30 billion of inflows in Indian bonds over the course of 10-12 months. We expect much of the inflows to be frontloaded as active investors might want to front-run passive flows,” he says.

Bond moment

While inflows into G-Secs are a given, the secondary effects of these in the corporate bond market are to be watched for.

Nearly four years ago, the Securities and Exchange Board of India said that large companies with ratings of ‘AA’ and above should borrow 25 per cent of their funding through the bond market. The idea behind this was to slash their reliance on bank finance and lower the cost of financing. It also addressed another concern: The inability of banks to fuel India Inc’s appetite for funds, given their own capital concerns and the provisioning needs on dud loans. It was also desirable on its own as a measure for banks being the only lenders in town is an archaic notion, (though it’s only the US which has a deep corporate bond market in the truest sense). Then, you have the issue of financing the country’s infrastructure. The National Infrastructure Pipeline had envisaged Rs 111 trillion of investments between FY20 and FY25 – all of this can’t flow from banks.

As CRISIL Ratings sees it, capex in the infrastructure and corporate sectors is expected to be driven by decadal-high capacity utilisation, healthy corporate balance sheets and strong economic outlook. It foresees capex of Rs 110 trillion between FY23 and FY27, or 1.7 times what was seen in the past five financial years; and this pace of capex will continue past FY27.

“The corporate bond market is expected to finance a sixth of the capex foreseen,” says Gurpreet Chhatwal, managing director at CRISIL Ratings. He feels that infrastructure assets are becoming strong contenders for investment because of their improving credit risk profile, recovery prospects and long-term nature. Currently, infrastructure constitutes only 15 per cent of the annual corporate bond issuance by volume. “But structural improvements, aided by a raft of policy measures, should make infras­tru­cture bond issuances amenable to patient capital investors – insurers and pension funds – the key investor segment in the bond market.”

Debt protection

The elephant in the room is the success of the Insolvency and Bankruptcy Code: Its linkage with the bond market is critical. “Currently, highly rated bonds attract domestic and foreign investors. Certainty of outcome (of debt resolution) within a realistic time frame will build investor confidence in bonds issued by lower-rated issuers,” says Divyanshu Pandey, partner at S&R Associates. This will help deepen the primary and secondary bond markets. This seems to be a distant dream, though. That is because a key difference between the bond market and the bank-loan market is that in the former (in many cases), bondholders at the time of default might not have had direct contact at all with the issuer, because they would have traded hands many times over. “It becomes all the more difficult to get a resolution going with such a diverse investor group, who may not be aligned in their approach on the outcome and could pull in different directions,” says Pandey.

Another variable also needs to be looked at. Data suggests 94 per cent of the bond issuances are rated in the highest safety (‘AAA’) and high safety (‘AA’) rating categories. CRISIL Ratings portfolio shows that performance of ‘A’ rated category corporate bonds have been strong and resilient, with low default rates over the past decade. Their debt protection metrics have also improved significantly over the past five years. For instance, mid-rated ‘A’ category rated corporates today showcase leverage metrics that are similar or better than ‘AA’ corporates a few years ago. This indicates prudence in capital allocation/capital expenditure (decisions by mid-rated issuers.

While the benefits of inclusion in global bonds indices will result in steady incremental annual inflows, flattening of G-sec yield curve, appreciation of the rupee and reduction in borrowing costs, when concerns emerge about the fiscal health, there are worries of a potential rating downgrades or de-platforming from the index.

Last Thursday, Das called attention to the elevated level of public debt in many countries, including some of the advanced economies (AEs). Global public debt to GDP ratio is projected to reach 100 per cent by the end of this decade.

The public debt levels in AEs are in fact much higher than those in the emerging market economies. “As regards India, given the fiscal consolidation path as well as improving growth prospects, we expect the general government debt to gradually come down,” he said.

It would not be misplaced to expect an India sovereign rating upgrade.