Indian sovereign debt is set to see sizeable foreign inflows in 2024-25, but the local currency may not appreciate much due to the Reserve Bank of India (RBI) exercising close control over the exchange rate.
Starting June, Indian government bonds will become a part of JPMorgan's Government Bond Index-Emerging Markets (GBI-EM) global index suite, which is seen bringing in foreign money to the tune of nearly $25 billion into local debt over a 10-month period.
Also Read: Confident of handling higher inflows post JPMorgan bond index inclusion, says RBI Governor
"The index is about $230 billion. India's weight is about 10 percent, so $25-30 billion of additional flows (could come). And I think that there will probably be limited appreciation from just that quantum," Chetan Ghate, director of Institute of Economic Growth and former member of the Monetary Policy Committee (MPC), said on February 16.
Ashima Goyal, Emeritus Professor at Mumbai's Indira Gandhi Institute of Development Research and a current member of the MPC, added that considering the inclusion of Indian debt into JPMorgan's indices will be over a period of 10 months, the development is unlikely to "create any volatility" and that it will be absorbed.
"It might bring down (bond) yields, lower the cost of government, etc which should be useful," Goyal said.
Ghate and Goyal were speaking at Indian Institute of Management-Kozhikode's inaugural annual conference on macroeconomics, banking, and finance.
According to Sajjid Chinoy, JPMorgan's chief economist for India, the RBI will actively mop up the incoming foreign money.
"China got almost $250 billion of bond flows in the pandemic and the CNY-USD rate did nothing. My sense is that given past behaviour, the central bank (RBI) will absorb all of these flows," Chinoy said at the aforementioned conference.
"India's reserves, unlike the rest of Asia, are not earned reserves to current account surpluses – they are borrowed reserves in terms of capital flows. So my sense is that the impact on the rupee will be minimal," he added.
Problem of plenty
In addition to bond index-led inflows into Indian government debt, Chinoy sees foreign inflows into India rising due to other factors too and creating a "massive problem of plenty" in 2024-25. Chief among these factors are flows that react to changes in interest rates.
The different between US and Indian policy rates is just 100 basis points at the moment, with the former at 5.25-5.5 percent and the latter 6.5 percent.
"In the next 18 months, when the US cuts, they are going to cut at least 200-250 basis points… the RBI is going to cut much less. So the interest rate differential will widen in India's favour," Chinoy said.
"And then if you get a perception of a strong election result, you will get more equity flows," he added.
The Lok Sabha elections are likely to be held in April-May.
Fed Funds futures prices indicate that markets are expecting a 25-basis-point reduction in the US interest rate to 5-5.25 percent at the Federal Open Market Committee's meeting in June, with a nearly one-in-three chance of the federal funds rate target range ending 2024 at 4.25-4.5 percent.
Meanwhile, economists see the RBI beginning to cut the repo rate in June or August.
Sub-repo bond yields?
Given that the Indian government also plans to borrow less from the market through bond issuances to finance next year's fiscal deficit, demand for government bonds is set to exceed their supply in 2024-25 so much so that the RBI will have to step in and sell bonds in the open market.
According to Jayesh Mehta, formerly managing director and country treasurer for India at Bank of America, market dynamics could result in a big drop in bond yields next financial year.
"I think, trajectory wise, we are going to 6.8 percent even without a rate cut," Mehta said at the same conference, referring to the yield on the 10-year government bond, which ended at 7.10 percent on February 16.
"It can go below that also. But with these kind of flows, the RBI has to give some supply (of bonds) otherwise it may actually go below repo rate," he added.
Also Read: After JPMorgan, Indian govt bonds could be part of Bloomberg indices in 2024
Chinoy of JPMorgan, too, thinks that the RBI may end up engaging in open market sales of government bonds depending on how it manages the foreign inflows post India's inclusion in the JPMorgan bond index.
"If the RBI is buying dollars and buying it forward, there is no increase in rupee liquidity and net demand for bonds will go up. But if you are buying spot and generating rupee liquidity beyond which you normally create money, then there may well be a situation where you have to sterilise through OMO (open market operations) sales, hypothetically," he said.
"So the impact on the bond market is offset because foreigners are buying and the central bank is selling… This is simply a switch in the central bank's balance sheet away from net domestic assets to net foreign assets."
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