Five key implications of JPMorgan's India bond index inclusion

According to economists, if the JPMorgan inclusion process is stable, India could potentially become a part of even bigger global bond indices in 2025.

JPMorgan's September 22 announcement that Indian government bonds will be a part of its Government Bond Index-Emerging Markets (GBI-EM) global index suite from June 2024 has set off anticipation that foreign investors will pump in billions of dollars into India to buy its sovereign debt. However, that is just the tip of the iceberg, with the inflow of these funds set to have a wide-ranging impact on the Indian financial system and macroeconomic fundamentals.

Here, Moneycontrol takes a look at five key implications of the huge influx of foreign capital expected into the Indian sovereign debt market following JPMorgan's decision.

Quantum mechanics

Economists have pegged the quantum of inflows following this development at $24 billion. The inclusion will happen in 10 monthly increments of 1 percentage point each, starting June 28, 2024. As such, the funds will flow in over a period of 10 months and not in one go.

Also Read: A decade in the making, India's global bond index inclusion journey finally ends

According to Namrata Mittal, SBI Mutual Fund's Chief Economist, the number could be even higher at $28 billion as India's presence will rise in not just in the GBI-EM Global Diversified index, but also other JPMorgan indices such as the JADE Global Diversified index and the JADE Broad Diversified index.

"…whether $24 billion or $28 billion, we are talking about such an inflow when everyone is completely tracking the Index weights. Overweight/Underweight could potentially translate into higher/lower inflow," Mittal said, adding that some clarity was also needed on the purchases already made by foreign investors in government securities under the Fully Accessible Route (FAR).

"JPMorgan does not give an explicit bifurcation of investors with passive or active benchmarking… where we need clarity is FIIs have already invested $8.5 billion in FAR securities. So is this $24 billion over and above this $8.5 billion or does it get partly offset," Mittal explained.

Demand over supply

Greater foreign inflows next year will result in increased demand for Indian government bonds. At the same time, 2024-25 could also see the Centre borrow a smaller amount compared to Rs 15.43 lakh crore this year as the fiscal deficit target could be around 5.5 percent of GDP. This dual movement of increased demand for and possibly reduced supply of government bonds could result in the former exceeding the latter by as much as Rs 90,000 crore, according to Gaura Sen Gupta, IDFC First Bank’s India economist.

Also Read: Centre hopes to lower annual borrowing to Rs 12-13 lakh crore in next few years

Sen Gupta is not alone in thinking this.

"Demand for G-sec (government securities) could now outstrip supply… This could be a new turning point in the G-sec market in India where supply has traditionally outstripped demand for G-sec," Soumya Kanti Ghosh, State Bank of India's group Chief Economic Adviser, said in a note on September 25.

The natural consequence of the above is lower bond yields. According to Ghosh, the 10-year government bond – which closed at 7.15 percent yield on September 25 – could fall to 7 percent yield by the end of 2023-24 and "should affirmatively breach 7 percent" next financial year.

UBS, meanwhile, has lowered its 2024 forecast for 10-year yield to 6.75 percent from 7 percent.

From rupee to CAD

Capital inflows should mean a stronger rupee. But according to Barclays, the US dollar's strength and rising crude oil prices will prove to be headwinds, at least in the short term.

"That said, in a strong US dollar environment, the Reserve Bank of India (RBI) will continue to play a crucial role in our view, and may also likely accumulate dollars passively to absorb any heavy flows, given its focus on ensuring a more stable currency on top of internationalisation efforts," Barclays added.

On this, there is general agreement – from the Indian government to JPMorgan itself – that the central bank will have to keep buying dollars.

Even though the RBI is expected to step in and keep the rupee from appreciating wildly, the external balance will nonetheless improve. According to HSBC economists, the large inflows will likely keep the Balance of Payments "in strong surplus" even though the current account deficit may widen.

Sen Gupta of IDFC First Bank sees the current account deficit in 2024-25 at 2 percent of GDP, unchanged from 2022-23.

Increased scrutiny

India's inclusion in global bond indices is not all good news. A key challenge would be outflows – and the associated financial market volatility – due to non-India developments. That, as Chief Economic Adviser, V Anantha Nageswaran, said, is something the authorities must prepare for.

"As India's G-sec market attracts more global flows, it could also become more dependent on global financial conditions, which could add volatility. Strong institutions-backed, rules-based policy making will become even more critical in such times," HSBC economists added.

One rule that will certainly become more critical is the Finance Ministry's annual fiscal deficit target. The Centre aims to cut it down to 4.5 percent of GDP by 2025-26 and the idea – at least to begin with – was to reach 3 percent. With more eyes on India's fundamentals, annual fiscal slippages may not be tolerated to the extent they have been until now.

Eyes on the next big thing

With JPMorgan done, eyes are on a couple of other index providers: FTSE Russel and Bloomberg Global Aggregate Index. And there is excitement building on what a potential inclusion into these indices could mean in terms of inflows into India.

"…the FTSE Emerging Markets Government Bond Index-Capped oversaw total funds of $1,477 billion as of end August, making it six times-plus larger than JPMorgan GBI-EM GM!" SBI's Ghosh wrote in his note.

"If the inclusion process at JPMorgan GBI-GM materially stabilises, we can see another BIGGER inclusion by mid-2025!!" he added.