Inclusion of Indian bonds in the JP Morgan index faces hurdles

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By sounding out big investors on adding India to its emerging-market bond index, JPMorgan may have kindled hopes – yet again-- of including Indian government bonds, known as G-Secs. But while the prospect of being included in a global debt index raises optimism, what matters more is whether or not international investors find India to be an appealing market.

For, even as Indian government bonds are amongst the most liquid globally, a cap on foreign ownership of government bonds, and complicated tax issues for foreign investors may act as the wet blanket.

Last week, the Wall Street bank said it was seeking opinions from investors on whether to include the country's sovereign bonds in JPMorgan's GBI-EM Global Diversified Bond Index. This move sparked a bond rally and reignited rumours of massive inflows that would help the country finance its current account and fiscal deficits.

India’s $1 trillion sovereign bond market is one of the biggest emerging markets not to be part of any global index.

JPMorgan’s latest move comes even as the inclusion has been stalled for months. Reportedly, over the past two years, the finance ministry and RBI have met with index managers of at least three global benchmark indices, viz Bloomberg Barclays Global Aggregate Index and JP Morgan GBI EM Index, for India’s inclusion, but the index providers have been wary.

For one, the controversial capital gains tax on foreign investors had been a major deterrent since India has been opposed to providing any kind of tax waiver even if it delays its goal of getting its bonds included in global bond indexes. Under existing rules, an overseas investor is required to pay a 30% short-term capital gains tax if a listed bond is sold within 12 months. Domestic investors, in contrast, pay short-term capital gains tax on debt investments based on their tax slabs and 4% cess.

According to Madhavi Arora, lead economist at Emkay Global Financial Services, global investors want India to list its bonds on international clearing platforms -like the most popular global bond settlement platform Euroclear, which help settle securities transactions. And all clearing houses, including Euroclear, have pressed India to exempt the transactions from taxes in order for it to happen and to prevent compliance concerns. For instance, although Euroclear is active in 49 countries, none of them impose capital gains taxes on bond trades made through its platform. Since JP Morgan insists that trades be settled in Euroclear for inclusion in its emerging market bond indices, the fact that Indian authorities are refraining from abolishing the capital gains tax, could mean that the inclusion may not happen anytime soon, she adds.

Secondly, the depth of a country’s debt markets is also an important criterion for inclusion and reportedly, that’s the other concern of JPMorgan. Despite RBI’s recent efforts to broaden the investor bases through Retail Direct Scheme and the unbridled access to select bonds, JPMorgan is concerned that the G-Sec markets have been traditionally dominated by large institutional investors like insurance companies, debt mutual funds and banks.

Despite the eligibility to hold $32 billion worth of G-Secs, the FPI holding of the most liquid and highly rated debt instrument is a mere 28% (as on 26 August 2022), according to the Clearing Corporation of India data. This is why, according to Mahendra Jajoo, Chief Investment Officer - Fixed Income at Mirae Asset Investment Managers---what is more important than the index inclusion is whether foreign investors consider India as an attractive market for debt. The existing limits of government and corporate debt for foreign investors, after all, has remained underutilized for the better part of the last 2 years. According to Jajoo, in a competitive world, a positive macro environment combined with a monetary policy that provides an incentive compared to other competing markets, for example Brazil or Mexico, is relevant.

Still, the fact that Indian bonds are getting pulled up on the radar of an international index means that India follows a liberal regulatory regime and possesses enough liquidity in its bond markets.

While the JPMorgan consultation is expected to be complete by next month with the announcement of an official proposal expected in October, according to FT, the other major index provider FTSE Russell had placed Indian government bonds on a watch list in 2021 for possible inclusion. Although, unlike JP Morgan, FTSE Russell declined to comment on India’s assessment status, these moves could force global investors to take greater interest in bonds, say experts.

And expectations are already running high.  If India is included in the indices, there can be two types of foreign investor flows: Index tracker passive inflows and active investors’ inflows, says Neeraj Gambhir, Group Executive –Treasury, Markets & Wholesale Banking Products at Axis Bank. While India's weight in the index will influence passive inflows, additional flows will depend on the involvement of active investors, who, according to him, may inject $30 to $40 billion annually if India is included in JPMorgan's bond index.

Others are hoping India's resolve to craft consistent tax policies and well-defined entry and exit criteria over a period of time, should also help in increasing global index providers’ confidence in domestic markets.

For instance, the inclusion (in JPMorgan's index), even if it happens at a later part of the year, would be beneficial, says Teresa John, lead economist at Nirmal Bang. She adds that besides attracting funds at a time when FPI flows have languished lately, the move could also soften bond yields at the margin, which has been an RBI concern lately, despite the fact the weight assigned to India at the time of inclusion may not be high and the flows are likely to come in a trickle rather than a flood.

(Indrajit Basu is an India-based business/technology journalist with over 25 years of experience in international and local publications. He covers IT/technology, telecom, business/finance, and current affairs.)   

Views are personal and do not represent the stand of this publication.