RBI group says gains from including govt bonds in global indices outweigh risks

Inclusion of Indian government bonds in global indices is estimated to bring in foreign inflows to the tune of tens of billions of dollars.

The gains from adding Indian government bonds to global indices are greater than the risks, a report by Reserve Bank of India (RBI) staff has said.

"On the whole, the benefits of index inclusion appear to outweigh the concerns associated with it," the RBI's inter-departmental group on internationalisation of the rupee, headed by executive director Radha Shyam Ratho, said in a report released on July 5.

It has recommended that the RBI "may step up measures to engage with index providers for the inclusion of IGBs (Indian Government Bonds) in global bond indices".

The RBI said the group's report does not reflect the central bank's official position, though it will examine its recommendations.

The observation comes amid prolonged discussions between Indian authorities and providers of global bond indices which began in the aftermath of the "taper tantrums" of 2013 that saw the rupee slip to all-time lows as foreign investors exited India in droves.

Gains versus concerns

While the benefits from the inclusion of Indian government bonds in global indices are clear as they would result in passive investments worth billions of dollars, one of the risks is that passive investors could all exit together during uncertain times, resulting in huge pressure on the rupee.

The RBI group report also noted that index inclusion can lead to "increased sensitivity of domestic policy to external spillovers" and fiscal and monetary policies will need to be "more cognizant of global perception and sensitivities".

While foreign investors can invest in securities issued by the Indian government, their investments are currently well below permitted levels.

Data from the Clearing Corp of India shows that foreign investors have used only 17.7 percent of the limit on their investments in government securities. According to the RBI group's report, one reason could be that India is the "notable exception amongst major emerging markets that does not feature in global bond indices".

Talks on

As per the report, the RBI has been in talks with the index providers, including JP Morgan, FTSE Russel, and Bloomberg-Barclays, with the takeaway being that there is "increasing interest" in making India a part of these indices, especially with India already on the watch-list for inclusion in two indices — JP Morgan Global Bond Index–Emerging Markets and FTSE Emerging Markets Global Bond Index.

However, over the years, a bone of contention between India and index providers has been the tax treatment for gains made by foreign investors from the sale of Indian government bonds once they have been listed on the indices.

India is reportedly not in favour of providing any favourable tax terms, with a senior finance ministry official telling Moneycontrol in August 2022 that the government was not "desperate" to get its bonds listed on the indices.

As far as the government is concerned, the ball is in the index providers' court, with the RBI group's report also saying the "timeline for the inclusion would be contingent upon the decisions by the index providers". However, India's inclusion would require a reshuffle of other countries' weights in the indices.

As such, investors who passively follow these weights while making their investments would need to sell certain securities. This could be a sticking point for the index providers as the sharp increase in interest rates globally over the last year has led to a fall in bond prices. Selling these assets to make room to purchase Indian government bonds would then lead to losses.

As per estimates made by Goldman Sachs in August 2022, India's inclusion in JPMorgan's Government Bond Index-Emerging Markets Global Diversified Index could bring in $30 billion into Indian government bonds over a 10-month period, assuming India gets a 10 percent weight in the index.

Similarly, Goldman Sachs predicted that if India became a part of the Bloomberg Global Aggregate index, another $10 billion worth of inflows could come in, assuming India was given a weight of around 0.44 percent.

Goldman Sachs had said last year that it expects India to be included in JPMorgan's Government Bond Index-Emerging Markets in 2023.