Indian bond market is coming of age

The inclusion of Indian bonds in global bond indices as an important milestone towards the internationalisation of the rupee.

The Indian bond markets were in for a triple treat in the last few days. Indian government bonds were included in the JP Morgan Emerging Market Global Bond Index. This was followed by the Indian government announcing that it would issue 50-year sovereign bonds and 30-year sovereign green bonds, for the first time. All these three developments add to the growing importance of the bond markets in the Indian financial system. Let us review the three developments and discuss their implications.

Global Recognition

The first is the inclusion of Indian government bonds in the JP Morgan Global Bond Index-Emerging Markets (GBI-EM). JP Morgan formed the GBI-EM index in the 1990s after the issuance of so named Brady Bonds. These bonds were named after the then treasury secretary Nicholas Brady who helped Latin American economies restructure their outstanding debt via new sovereign bonds denominated in US dollars. Just as the Nifty and Sensex act as benchmarks for equity markets, the GBI-EM bond market index acts as a benchmark for emerging market bond markets. Global investors seeking to invest in bonds of emerging markets can analyse the returns and risks based on this benchmark. The fund management industry started launching active and passive funds of emerging market debt based on this benchmark.

Over time, JP Morgan created three indices within the GBI-EM category – EMBI Global, EMBIG Diversified and EMBI+. India has been included in the EMBI Global fund. Currently, total funds worth $236 billion are benchmarked on the three GBI-EM indices, of which $213 billion are benchmarked on the Global Fund index, which is nearly 90 percent of the GBI-EM family. Apart from JP Morgan, FTSE Russell and Bloomberg-Barclays have also developed their own bond indices.

JP Morgan uses the criteria of income and purchasing power parity, and India has met the criteria now. The index has listed 23 securities which are eligible to be included. The index is based on a floor of one percent and a cap of 10 percent, which means the minimum share will be one percent and the maximum share will be 10 percent. The index will start including Indian bonds with a one percent share from June 2024 and then gradually increase the share to a maximum of 10 percent over 10 months. The inclusion of India’s bonds in the JP Morgan index has been anticipated for a while. Officials from the government and the RBI have been talking to the index companies for inclusion in the three global indices. JP Morgan and FTSE Russell had put India on the watchlist. India joins 16 countries that are in the bond index in the JP Morgan index. In the future, the other two indices are likely to include Indian bonds, thus creating a more enabling environment in Indian bond markets.

Foreign Funds To Come

How will the inclusion help the economy? First, it adds to the prestige of Indian bond markets. Just like it is a matter of prestige for a listed company to get included in the Nifty and Sensex indices, similarly it is prestigious for Indian (or any country’s) bonds to be included in the global bond indices. Second, the inclusion in indices leads to investment flows into the selected security. In the case of Indian bonds, it will mean foreign investments in Indian bonds might rise. Currently, foreign investors’ participation in Indian bond markets averages 1.5-2 percent of total investments. Higher foreign participation will not just deepen bond markets but also lead to higher capital inflows, which will help manage the current account deficit. As of now, the current account deficit is managed mainly via equity flows in the form of foreign portfolio investment and foreign direct investment. In the future, debt flows might also help in narrowing the deficit. Third, higher investment flows should also help lower interest rates in the economy.

While the inclusion looks positive, there are some potential pitfalls too. First, if inflows are high, it could lead to higher inflation, complicating RBI’s monetary policy. Second, actual inflows could also be less than expected inflows because expectations change all the time. Third, the inflows also mean there can be outflows as well, creating volatility in markets. Indian policymakers have been open to inviting inflows in equity markets but not in debt markets, as it creates problems in case of sudden outflows.

Longer Tenure Bonds

The second development of issuing a 50-year government bond is part of the policymakers’ efforts to lengthen the tenure of bond markets. Post-1991 reforms, India started reforming its debt markets in a series of steps. Before 1991, the RBI was a major player in the government bond markets, thus financing the government deficit. From 1997 onwards, the RBI was prohibited from participating in the primary government bond market. The central bank developed a secondary debt market by instituting primary dealers who acted as market makers of the bond market. The government gradually started issuing bonds across maturities. Longer-dated securities suggest the confidence of both the issuer and the investor. Initially, the longest-dated security was 10-year bonds, and over time, the government has issued bonds in 15-, 20-, 25-, and 30-year tenors in the decade of the 2000s. In 2015, the government issued a 40-year bond and now it plans to issue a 50-year bond. These longer-dated securities mainly help insurance and pension fund industries that seek long-term investments for their portfolio.

The third development of issuing 30-year green bonds is an addition to the growing bouquet of government bonds. Green bonds, as an investment category, gained prominence in the last few years. The proceeds from green bonds are invested in greening the economy. The Indian government issued green bonds for the first time in January 2023, worth Rs 16,000 crore split equally between 5-year and 10-year bonds. The 30-year bonds will enable the government to undertake green projects for a longer duration.

To sum up, the last few days have added to the list of growing reforms and developments in India’s bond markets. The JP Morgan index may have included Indian bonds in its index only in 2023, but Indian bond markets have made tremendous progress since 1991. The inclusion of India’s bonds in the JP Morgan index will also help advance the project of internationalisation of the Indian rupee. The report of the RBI’s interdepartmental group on the internationalisation of the rupeementioned the inclusion of Indian bonds in global bond indices as an important milestone towards the internationalisation of the rupee. Russian politician Vladimir Ilyich Lenin famously remarked, “There are decades where nothing happens; and there are weeks where decades happen.”  Lenin made these remarks for the ongoing political turmoil and revolutions where large-scale once unimagined changes were happening rather quickly in Russia and the world. The quote applies to Indian bond markets as well where decades have happened in a few weeks.

Amol Agrawal teaches at Ahmedabad University, and is the author of ‘History of Private Banking in South Canara district (1906-69)’. Views are personal, and do not represent the stand of this publication.