The recent inclusion of Indian government bonds in the JP Morgan Emerging Markets Bond Index (EMBI) marks a watershed moment in India's financial ecosystem. The total number of outstanding Bonds stands at $2.59 trillion and has foreign ownership of about 2%. With this inclusion, we anticipate about $25-30 billion in terms of passive fixed income investments to come into the country in the next 10 months.
While the short-term impact may seem limited, the long-term implications are profound and far-reaching. This pivotal moment will not only attract new capital to the market but also catalyse investment in private sector bonds, setting the stage for sustained growth and development in India's financial markets.
Immediate and short-term effects
Initially, the impact of this inclusion may appear modest as foreign investors are already well-positioned for this shift. Since the announcement in September 2023, $10-11 billion of FPI inflows have already come into the government bond market. This is evident in the market as the benchmark 10-year G-Sec was unchanged on 28th June at 7%.
However, this move places India prominently on the global financial map, mandating index tracker funds to allocate investments in Indian government securities. This is merely the beginning of a significant multi-year cyclical flow of investments into the country and the latent demand effects will start showing from next month onwards.
Medium to long-term impacts
As foreign investors gain confidence in India's macroeconomic stability, their investment strategies typically evolve. Initially, they start with risk-free government securities to assess the country's economic environment. Over time, as their comfort level increases, these investors diversify into public sector enterprises, government-owned enterprises, and eventually corporate bonds. This progression highlights the broader potential for diverse investments across the credit continuum in India, contributing to a vibrant and robust bond market.
From around six to nine months onwards, we can expect to see the second-round effects materialize. These effects will be characterized by a gradual shift of foreign investment down the credit curve, leading to increased participation in corporate bonds. This influx of capital into the private sector will not only enhance liquidity but also lower borrowing costs for companies, stimulating further economic growth.
Sustained inflows
India stands out as an attractive destination for foreign investors, offering government bond yields of over 7%, nearing the peak of interest rates, and experiencing low volatility of INR on the currency front. These factors make India an exceptionally promising market for stability and growth, especially as other large economies like Russia have become uninvestable and China has had its own recent economic troubles. Also people should be aware that China 10-year local government bond (CGB) trades at 2.20% .
As the global economic landscape evolves, particularly with potential rate cuts from the Fed, we expect a shift in developed market flows into emerging markets. This movement will further propel investment into Indian bonds, reinforcing the positive trend.
Size of economies and their open architecture for investments play an important role in global asset allocation strategies. India stands as the 5th largest GDP in the world and has the highest growth rate projected at 7.2% as compared to any other Top 20 countries ranked by GDP. Hence, now as the FAR (Fully Accessible Route) Bonds have got index inclusion, we expect sustained inflows – both passive as well as active – becoming an important creator of capital in the country.
Conclusion
The inclusion of Indian government bonds in the JP Morgan Emerging Markets Bond Index is a transformative event for India's financial markets. This coupled with the growing domestic retail participation in bond investment provide an almost perfect convergence onto the fixed income asset class at a perfect time in the interest rate cycle. This progression underscores the broader potential for diverse bond investments in India, setting the stage for a vibrant and robust capital markets in the years to come.
(The author is Co-Founder of IndiaBonds.com. Views are personal)
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