JP Morgan’s decision to include India in its global bond indices in 2024 signifies the country’s growing prominence in global financial markets and will bring in billions of dollars of foreign fund flows, a top executive at an Indian pension manager told AsianInvestor.
“It will boost India’s bond market by bringing passive flows of $25-$30 billion between June 2024 and March 2025 and will support further development of domestic capital markets,” said Sriram Iyer, CEO of India's HDFC Pension Management Company.
HDFC Pension Fund
It is one of 10 pension fund managers that operate under the National Pension System, a voluntary defined contribution retirement savings scheme introduced by India's central government in 2008.
HDFC Pension Management Company is a wholly-owned subsidiary of local insurer HDFC Life Insurance.
BOOST TO BONDS
JP Morgan in late September announced that it would add India to its widely tracked emerging market debt index.
India’s local bonds will be included in the Government Bond Index-Emerging Markets index and the index suite, benchmarked by about $236 billion in global funds, the financial institution said.
The new set of investors will likely free up some capital for existing domestic investors, especially domestic banks, who are currently the largest holders of sovereign debt, Iyer said adding that for new international investors, India represents an opportunity to diversify portfolios.
The inclusion of Indian government bonds will be staggered over a 10-month period, starting from June 28, 2024, until March 31, 2025, increasing in weight by 1% every month.
There are 23 Indian government bonds with a notional value of $330 billion eligible for index inclusion, according to JP Morgan.
More foreign investor participation could also result in better price discovery and lower the cost of capital, said Carol Lye, portfolio manager and senior research analyst at Brandywine Global.
Currently foreign investors hold less than 2% of outstanding government debt. Foreigners have purchased about $3.4 billion in government bonds so far in 2023.
Kenneth Akintewe, head of Asian sovereign debt at abrdn, said the index inclusion will strengthen India’s global ambitions.
“Generally, we expect investors to get ahead of the curve and start allocating to the asset class before the official mid-2024 inclusion date,” he told AsianInvestor.
“There are around 150 emerging-market local currency funds in the Morningstar category.
"There will be a scramble for these to complete the challenging registration process. As soon as accounts are approved, they will likely start building positions.
"That could be as soon as four-to-six months from now for the non-passive emerging-market funds. Given the potential for Indian bonds, we think many investors will want to hold overweight positions,” Akintewe added.
HDFC Pension’s Iyer also noted that the move would help provide stability to the Indian currency against the US dollar and protect against volatility in the global commodities market.
The Indian rupee could strengthen in the medium term as the balance of payments improves due to higher capital flows.
The rupee has shed about 15% against the US dollar in the past five years.
Other experts noted that greater investor participation -- and therefore scrutiny – could focus the government to whittle down its fiscal deficit.
India’s fiscal deficit - the gap between government revenue and government expenditure – is estimated to reach 5.9% of GDP in the 12 months to March 2024, lower than the 6.4% deficit reported in the year-ago period.
The deficit indicates how much the government needs to borrow to finance its operations. When the fiscal deficit is high, inflation and currency devaluation are likely.
NOT ALL GOOD
There are some downsides to index inclusion.
"A downside of all of this, however, will likely be increased volatility, especially if we see a macro upset,” said abrdn’s Akintewe.
Lye of Brandywine said another challenge is high withholding taxes and “Euroclear issues”, which could reduce the attractiveness of government bonds even with index inclusion.
Euroclear is one of Europe's main clearinghouses for traded securities. Allowing Indian bond trades to be settled offshore is a topic of ongoing discussion with India's central bank and market participants, according to local media reports.
There are also tax issues on income earned from rupee-denominated bonds.
For now, Indian financial markets are expected to remain range-bound and volatile in a rising yield environment and ongoing geopolitical tensions, said HDFC Pension’s Iyer.
Market sentiment will be supported by strong corporate balance sheets, moderate inflation and an expected pick-up in India’s growth trajectory, he added.