The Bloomberg Index Services announced on Monday, 8th of January, 2024 through a consultation document that Indian Government Bonds are going to be included in its Emerging Markets Local Currency Index from September 2024. The last time that the country’s economic growth bolstered because of foreign portfolio investments was back in the FY 2007-2008, when the government eased out the procedures for foreign portfolio investments which attracted an enormous $29 billion into the country’s economy as foreign investments. The inclusion in the EM index brings about growth at a much larger scale when compared to the growth that was witnessed in the FY 2007-2008. This development marks a remarkable stride for India in the foreign capital market.
To fully comprehend the effect of this announcement, we have to rewind back to April of 2020. The Indian Government has been considering inclusion of its securities in the global indices since 2013 however foreign investment restrictions impeded any progress. It was in 2020 that RBI introduced “Fully Accessible Route” (FAR) securities which allow non-residents to invest in specific government securities without any investment ceilings. Essentially, it eased restrictions for foreign investments. It is these FAR Government bonds that are going to be listed in the EM Index.
The discussion of including India in bond indices has been going on for almost four years now, coinciding with significant occasions like PM Modi’s meeting with Michael Bloomberg in the US in September of 2023, JP Morgan and FTSE Russell placing India on a “watchlist” for a possible listing, and the exclusion of Russia from international bond indices following the start of the conflict in Ukraine in February of 2023. In another milestone for the country, in September 2023, JP Morgan and Chase Co. opened the play by announcing that Indian government debt will be part of its Government Bond Index-Emerging Markets global suite from June 2024. In the three months following the announcement, inflows boosted to a six-year high for India. The inclusion of Indian government bonds in the JP Morgan’s index is projected to yield foreign portfolio investments of an enormous $30 billion into the Indian markets from the second half of 2024.
The Bloomberg EM Local Currency Government Diversified Index tracks the performance of emerging market nations’ fixed-rate local currency sovereign debt. The Index contains government bonds issued by investment grade and non-investment grade nations outside of the United States, in local currencies, with a remaining maturity of one year or more. The proposal calls for India FAR bonds to be incorporated into the Bloomberg EM Local Currency Indices in a phased manner during a five-month period beginning in September 2024. After complete inclusion, the Bloomberg Emerging Market ten percent Country Capped Index will have 10% of India’s FAR bonds as a cap. This will make the Indian Rupee the third-largest currency component in the index, following the South Korean Won and the Chinese Renminbi. Since its announcement, Bloomberg has released a consultation document seeking feedback from Index users on two questions: inclusion of Indian bonds and the phased approach that has been planned for this inclusion.
What is the impact of this inclusion?
Inclusion in global bond market indexes indicates widespread awareness and acceptability. It indicates that a country’s financial market has evolved and is now seen as a compelling choice for foreign investors. This inclusion underlines India’s attempts to open up its financial markets, making them more accessible and transparent to international investors.
- The biggest impact would be the widening of investor base. Currently, the majority investors of Indian Government bonds are Indian financial institutions. However as this proposed inclusion will increase the demand for these securities among foreign investors and result in passive inflows from the foreign market.
- The second round of impact would be through reduction of India’s Current Account Deficit (CAD) and increase in the Balance of Payments (BoP) surplus. India’s CAD is predicted to reach over 2% of GDP in FY25, driven by increased global and local growth and rising commodity prices. In this scenario, index-related inflows will fund greater CAD and increase foreign currency reserves.
- Inclusion in these indices usually results in reduced borrowing rates for the Indian government and enterprises. When a country’s bonds are included in global indexes, they become more liquid and less risky, possibly leading to a reduction in rates.
While India’s participation in the global bond index would boost local liquidity, it also poses macroprudential risks. Although larger foreign inflows are generally favorable for currency and bond markets, there are several factors to consider. Foreign flows are erratic and heavily reliant on external sources. When faced with a negative external shock, investors may withdraw from riskier EM assets, resulting in capital flight. This will leave India’s financial markets vulnerable to increased volatility.
Historically, capital withdrawals have led to fast depreciation of the rupee. Inclusion in the index exposes us to increased financial sector volatility. The RBI needs to closely monitor and intervene in this situation. The RBI faces the challenge of maintaining financial market stability and preventing spillovers into the actual economy.
K Satish Kumar, is an award-winning lawyer, Keynote Speaker, Author of multiple articles, and the Group Chief Legal Officer of an IT major – Intellect Design Arena Ltd. He is actively involved in many pro bono activities through Chennai Lawyers. The author can be reached at firstname.lastname@example.org. The views expressed are his personal.