A milestone on bond street

India's entry into a global bond index is a great sentiment-booster, but much of it has already been factored in

The 10-year government paper auction on Friday (June 28) for Rs 20,000 crore received 267 bids worth Rs 47,776.500 crore. Its cut-off yield was fixed at 7.0191 per cent. In the secondary market, the 10-year paper yield was hovering around 7 per cent for the better part of the last week.

This auction coincided with India’s inclusion in the JPMorgan Government Bond Index-Emerging Markets (GBI-EM) global index suite. Along with the 10-year paper, there was a 40-year bond auction that received 209 bids worth Rs 25,570 crore, with a cut-off yield of 7.1004 per cent.

Overall, there was no surprise on Day One of the inclusion – both in terms of bids and yields – although many expected yields to drop as the inclusion in the GBI-EM global index suite is anticipated to increase the demand for bonds, with greater participation of foreign investors. For bonds, yield and prices move in opposite directions; higher demand spikes prices and pushes yields down.

Clearly, the much-celebrated entry into a global bond index has already been factored in. The 10-year yield recently dropped to 6.95 per cent before rising to 7 per cent. Its highest level in the first quarter of the current financial year (April-June 2024) was 7.24 per cent.

India will gain a 10 per cent weight in the GBI-EM Global Diversified Index in phases, with 1 per cent added each month, reaching the limit by March 2025. 

Launched in June 2005 as the first comprehensive global local emerging markets index, GBI-EM tracks local currency bonds issued by emerging market governments.

It took a long time for India’s $1.3 trillion government bond market, the largest among emerging economies after China and Brazil, to enter the global index. We have been eagerly waiting for this landmark since October 2021 when India was put on the watch list, with 60 per cent of investors supporting its inclusion. At that time, JPMorgan said India needed to improve market access, trading, and settlement to achieve index inclusion.

Much earlier, in 2014, the Reserve Bank of India (RBI) explored the prospects of joining the JPMorgan index when India was facing its worst current account deficit, and the rupee depreciated sharply against the US dollar. It did not happen then due to strict regulations on foreign exposure to the Indian debt market in terms of maturity, quantum of investment, and the profile of the debt instrument. Progress has been made on these fronts, but the trigger for the inclusion is more to do with Russia’s exclusion from the index.

Russia had around an 8 per cent weight in the GBI-EM index. After its exclusion, Indonesia, Mexico, China, Malaysia, and Brazil – five of the 18 countries in the index – each have a 10 per cent weight. India, the 19th nation with access to the index, will be the fifth member of the 10 per cent-club by March 2025. India will eat into the shares of Malaysia and Brazil, apart from Thailand, South Africa, Poland, Czech Republic, Colombia, and others. Serbia, Uruguay, and the Dominican Republic have the least share – less than 1 per cent each.

Since June 2021, the RBI has been fine-tuning some reporting norms, offering more flexibility to foreign investors for buying government bonds. It has also allowed banks to lend to them for the margin requirements.

Ahead of that, in 2020, the RBI removed limits on foreign ownership in certain bonds by introducing the Fully Accessible Route (FAR). Eligible bonds for JP Morgan indices must have a notional outstanding amount of at least $1 billion and two-and-a-half years to mature. So, only those government bonds that are designated FAR and maturing after December 31, 2026, will be eligible to enter the GBI-EM global index suite. There are currently 29 such bonds.

Following the inclusion in the GBI-EM GD index, Bloomberg announced the inclusion of Indian bonds in the Bloomberg Emerging Market Local Currency Government Index and related indices, in phases over 10 months, starting January 31, 2025. FTSE Russell, a subsidiary of the London Stock Exchange Group, has also kept Indian government bonds on its watch list for possible inclusion.

Along with the GBI-EM Global Diversified Index, India is also expected to enter other JPMorgan bond indices such as the Asia (ex-Japan) local currency bond index called JADE Global Diversified Index, Jade Broad Diversified Index, and other aggregate suite of local currency indices. In these indices, India’s weight will be close to 15-20 per cent over the 10-month period until March 2025. Overall, JPMorgan government bond indices for emerging markets have $236 billion in assets under management (AUM).

According to the latest data from the Clearing Corporation of India Ltd, which settles government bond market transactions, foreign investors have used just 14.17 per cent of their allowed limit in the general category. Their investment in state development loans (SDLs) is 2.41 per cent of the limit. The aggregate holding of foreign investors in the FAR category is also very low – around Rs 1.86 trillion out of an outstanding portfolio of Rs 40.56 trillion.

Ever since the capital markets were opened to foreign investors, the flow of debt has been far less than equity. Also, the number of years when India has seen outflow in the debt market is far higher than in equities. Even though the equity market opened to foreign investors immediately after economic liberalisation in September 1992, the norms for foreign investment in debt were released in 1995. In FY93, Rs 13 crore of foreign money trickled into equities; four years later, in FY97, Rs 29 crore flowed into the debt market.

In the past decade, in FY14, there was a Rs 28,059 crore debt outflow even as the equity market attracted Rs 79,709 crore. In FY19, the outflow of debt was Rs 42,951 crore, which rose to Rs 48,710 crore in FY20 and further to Rs 50,443 crore in FY21. In FY23, there was an outflow of Rs 8,937 crore. The trend dramatically reversed in FY24, with a debt inflow of Rs 1.21 trillion; in the current year, up to June 26, Rs 11,055 crore flowed in.

Will the inclusion change the track of the bond market? One can expect $23-24 billion in foreign funds to flow in over the next 10 months – around Rs 17,000 crore a month. Once Bloomberg and FTSE Russell follow JPMorgan, the flow will increase. The inclusion will also facilitate passive flow to the Indian bond market, similar to index fund investment in Nifty, where every stock of a particular index gets investment according to its weight in the index.

How much has the Indian government been borrowing from the market? In the Covid-hit FY21, gross government borrowing zoomed to Rs 13.7 trillion (net Rs 11.43 trillion), almost double the previous year. In FY22, it dropped to Rs 11.27 trillion (net Rs 9.29 trillion), but rose to Rs 14.21 trillion in FY23 (net Rs 11.74 trillion), and to Rs 15.43 trillion in FY24 (net Rs 12.29 trillion). In the current year, the estimated gross borrowing is Rs 14.13 trillion (net Rs 11.75 trillion). On top of this, there are state development loans.

Local investors (primarily banks and insurance companies) have the stomach to support government borrowing, but greater foreign participation boosts sentiment. It will relieve pressure on banks and free up money for lending when most banks are finding it difficult to raise deposits to support credit growth. It will also have a positive impact on bond yields and the rupee, which recently saw its historic low of 83.72 per dollar.

On the flip side of India’s new bonding with global financial markets, a sudden outflow of foreign money, triggered by geopolitics, can cause volatility in bond and currency markets. However, with a chest of $654 billion in foreign currency assets (as of June 21), we need not worry about that.

The writer is an author and senior advisor to Jana Small Finance Bank Ltd . His latest book is Roller Coaster: An Affair with Banking. To read his previous columns, please log on to www.bankerstrust.in

X: @TamalBandyo