India joins the Global Bond League5 min read
Late on Thursday night, JPMorgan said it will include Indian government bonds in its widely tracked emerging market debt index. This means, over the next few years, you could see close to USD 20 Billion coming into Indian Govt bonds. Why is this important and how will it impact you?
First, some context – Today, Indian bonds, both Gsec and corporate bonds are open for investments by FIIs, but the offtake has been lukewarm, to say the least. FII ownership in Gsec is 1.59% as on June 20231, utilizing 23% of the limit made available to them by the RBI2.
The story is the same in corporate Bonds. FIIs own ~2.5% of the overall corporate bonds outstanding, utilizing only 15% of the limit available to them3. Compare this to the equity markets, where FIIs are the largest owners of Indian stocks, holding ~20% of the market. Both of these markets are comparable in size; Equity market cap is ~USD 3.79 trillion4, while the bond market (Gsec + Corporate bond + Tbills) is ~USD 3 trillion5.
So how will this Index inclusion affect Indian bond markets, and why is this important? Well for starters, it is important to appreciate the importance of passive funds. Passive funds hold more than 50% of global equity AUM. And it is not very different in Debt. Either explicitly, or implicitly, more than half of global AUM is managed passively6.
And passive funds are mandated to replicate the index they track, without any active management. Hence the importance of inclusion/exclusion from global indices. So while active global debt funds might have been vary of India (reflecting the low ownership of Indian Debt by FIIs) with Indian Gsec included in Global debt Indices, passive funds would now start investing in Indian Govt bonds, just because they are in these Indices.
How big is this? The AUM of funds tracking the JP Morgan Government Bond Index-Emerging Markets (GBI-EM) is USD 236 Billion7. India’s weight is expected to rise to 10% by Mar 2025. At current AUM, it means flows of ~USD 23.6 Billion. Which is close to the current holdings of FIIs in Indian Gsec. In essence, if this comes through, FII holdings in Indian Gsecs will double from their current levels.
More importantly, these flows will ease the pressure on incremental govt borrowing. For FY 24, the gross borrowing by the Govt is ~USD 175 Billion8. Flows from passive global debt funds could finance a fair chunk of this. And it is not just over these next two years. As global AUM shifts more to passive strategies, you will see a steady flow of FII investments in Indian Govt securities.
So how will this affect you as an investor? Remember that the risk free rate, i.e. the return on govt bonds is the most important rate of return for all investment decisions. With an additional source of funds, upward pressure on rates because of govt borrowing reduces. This reduces the cost of capital for the government, and consequently, for all corporations too. Which means, capex becomes that much easier to finance. This would lead to more investments, and hopefully, better growth in the economy.
But is it all positive? One of the reasons RBI and the Govt have been wary of FII investments in Debt is the fear of hot money flows. Remember, yields on govt bonds affect everyone’s borrowing rates. Sudden outflow of money from Gsec could raise yields on govt bonds, increasing the cost of capital across the economy affecting the capex cycle. So when there is an outflow of money from these passive funds, due to some global issue not pertinent to India, there would be outflows from Indian bond markets, thus negatively affecting yields and cost of capital for domestic investors.
We don’t have to go too far back to see this playing out. The taper tantrum issue in 2023 led to short term T bill rates going as much as 12%. In Aug 2013, 91 day Tbills were sold at a yield of 12.02%9. This was at a time when there was nothing wrong with the Indian economy. It was just a result of money flowing out of India, back into US, and the lack of depth in Indian markets leading to a very sharp rise in yields.
But all told, inclusion of Indian debt in global indices is worth celebrating. It brings in much needed passive FII flows into Indian debt markets, diversifying our borrowing sources, and potentially, improving the governance and quality of our markets, thanks to higher scrutiny by Index providers and global investors.
So what does this mean to you and your portfolio? Well, in the short term, nothing much. These are structural measures which take years to play out. This is another shot in the arm for the long term India growth story. So if your investment thesis is geared towards that, stay the course. In the short term, there would be minimal impact of this. In the medium term, you could see yields on govt securities lower than they would in the absence of this measure. In the long term, you would see corporations raising money at lower rates from the markets (both domestic and foreign), and this would benefit the domestic private capex cycle.
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1https://rbidocs.rbi.org.in/rdocs/Bulletin/PDFs/45T_18092023F725798DD9D84740AC5E37F84CC732F9.PDF
2https://www.fpi.nsdl.co.in/web/Reports/ReportDetail.aspx?RepID=1
3Debt investment by FII in Corporate Bonds is Rs. 103,535 Crores, out of a total corporate bond outstanding of Rs. 41,86,312 Crores
4Source – nseindia.com
5Gsec outstanding – Rs. 98,21,663.214 Crores https://rbi.org.in/Scripts/bs_viewcontent.aspx?Id=1956. Corporate bond outstanding – Rs. 41,86,312 Crores https://www.indiabondinfo.nsdl.com/. T Bills – Rs. 9,90,645 https://rbidocs.rbi.org.in/rdocs/Bulletin/PDFs/24T_18092023F9A1BB5FAF1849A4BBF291F4A9CC0B6E.PDF
6https://www.ft.com/content/73a6527d-cd59-498e-9923-af5143cbb952
8https://pib.gov.in/PressReleaseIframePage.aspx?PRID=1912058
9https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=29418
