Opinion With entry into JP Morgan bond indices, India is playing in the world

There are two other notable global bond indices — the FTSE EM Index and the Bloomberg Barclays EM bond index. So, will this JPM Index inclusion automatically lead to India’s inclusion in these indices? Not really. In fact, the procedural requirements and conditionalities are more stringent and these may be contingent upon tackling operational hurdles such as custody and settlement, clarity on taxation and Euroclear. However, there is no denying that once the Indian government bonds are included in the above benchmark bond index, it will impart a positive momentum and catalyse larger portfolio inflows on a sustainable basis. So, what does this inclusion mean?

First, it is widely understood that India is a large importer of commodities. However, what is under-appreciated is that India is also a huge importer of global capital and hence the country’s economic as well as business cycles are susceptible to greater gyrations in global capital markets in general and the US interest rates and the dollar in particular.

Second, the move will help ease the constraints around the financing of India’s twin deficits — the fiscal and current account deficits — by providing an alternate source of funds. It will structurally help lower India’s risk premia and the cost of funding which has long been a bugbear for borrowers. It will also deepen India’s bond markets, increase liquidity, widen the ownership of GSecs and lower the pressure on yields. Importantly, it will make the exchange rate stable, lowering the hurdle rate for FIIs investing in India. The Indian currency will benefit from the
resultant higher confidence of investors.

Third, corporates will benefit as the entire yield curve will move a notch lower, bringing down the cost of financing sustainably over time. Corporate bond spreads will now narrow and remain in check due to positive sentiments and flow momentum.

Fourth, the commercial banking sector will face less pressure to absorb a majority of government bonds and hence the balance sheets will have more wherewithal to lend to the needy private sector segments in the economy.

Fifth, India is currently on its way to building the infrastructure that it sorely needs. This is vital for creating the infrastructure backbone for realising the manufacturing-led growth ambitions. With public debt having risen faster and lagging the savings rate, bond inclusion can provide a source of long-term sustainable source of financing through investment in government securities.

Importantly, the timing of inclusion and the macro backdrop is interesting. The external environment has turned more hostile. The 10-year US treasury yield has risen rather sharply, and the US Fed remains hawkish. Yet another US government shutdown looms, posing a potential risk for markets. Moreover, the global trade and geopolitical backdrop remains uncertain.

The key question is whether the inclusion in the global indices will make India automatically entitled to huge resultant inflows. No, the underlying macroeconomic scenario will always matter more and there remain challenges that one should not lose sight of.

For one, the announcement of entry into the bond index will put the spotlight squarely on government finances and fiscal responsibility from hereon. Importantly, this is at a delicate juncture as India’s electoral calendar will not get bust with five state elections and then the general election. Rising crude oil prices pose a headache for the fisc and any relief via petrol or diesel price cuts or other sops will become tougher. Further, reliance on foreign funds for funding domestic deficits entails significant macro risks as was seen during the global financial crisis and the taper tantrum episodes. The inclusion will also expose Indian debt markets to greater volatility and link it to the vagaries of passive flows which allocate capital based on the weightage assigned by the index provider.

Further, several operational hurdles will need to be ironed out — the ability to clear and settle Indian debt on an international platform like Euroclear, repatriation of funds, and tax complexities including removing or lowering the capital gains tax compared to what domestic investors would pay.

Over time, the ongoing reform process, easier market access and transparency will shape and hasten the country’s integration into global markets, paving the way for a landscape of unparalleled market development, long-term capital inflows, and innovative financial products.

The writer is Group Chief Economist, L&T. Views personal