India might be part of Global Bond Index soon | More Dollars Inflow | Bond Market Explained |

Indian Bonds to join global index

WHAT'S HAPPENING ?

India recently overtook the UK to become the fifth largest economy of the world. And it is on track to clinch the third spot by 2030.

The recent global headwinds failed to dent its economy even as several big powers are staring at recession.

India is now the fifth biggest equity market as well. The country's $1 trillion sovereign bond market is one of the largest among emerging-market economies.

But, not with standing all these achievements, the country is still out of global bond indexes. The talks between the Central government and index holders have been on for long, but without a result.

But, now, there is a renewed push from global investors for India's inclusion.

WHAT HAS HAPPENED?

Indian government bonds are expected to be included in the JP Morgan Government Bond Index-Emerging Markets (GBI EM) in 2023.

According to analysts at multinational investment bank Goldman Sachs, owing to resolution of some operational issues and diversification of the index.

WHAT IS GLOBAL BOND INDEX ?

The basic purpose of an index is to track the movement of a financial instrument on which it is based.

Global bond indices help investors track the movement in bonds in multiple jurisdictions and aid in relative comparisons.

Indices perform the important function of being a benchmark to investments by mutual funds, pension funds and other large investors that typically prefer to hold onto investments for longer periods.

In other words, indices are guides to investments. In the equity markets, there are sectoral indices, besides the main ones that track the most traded stocks.

In the bond market, there are indices that track high-yield risky bonds, emerging market bonds and government bonds.

JP Morgan and Bloomberg-Barclay's are some of the major indices in debt markets that provide a wide range of indices from emerging markets to country specific to world indices.

However, getting included in these indices that are managed by financial firms or index holders is not easy. There is a strict criteria that has to be met.

WHY IS THE INCLUSION IN GLOBAL BOND INDICES CRITICAL ?

Global investors find it difficult and cumbersome to track bond markets in multiple countries.

This is where bond indices come in handy. Investors track key indices globally to make investment decisions.

More importantly, global funds seek to either match or outperform the returns of indices. Inclusion in these indices makes such decision-making easier for investors.

But above all that, index inclusion would mean a steady stream of dollar inflows from passively managed funds.

Therefore, for an emerging market economy such as India that is starved for capital, index inclusion guarantees a certain amount of dollar inflows regularly.

CRITERIA FOR INCLUSION IN BOND INDICES ?

Index holders or financial firms that manage bond indices have a series of criteria for countries wanting their bonds to be included in them.

They must meet parameters on liquidity, safety, and returns. The size of the market, sovereign rating, and ease of access are the main asks from index holders.

DOES INDIA MEET THESE CRITERIA ?

The Indian sovereign bond market ticks all the boxes in terms of liquidity, safety and even returns.

However, the tax policy does not meet the criteria for settlement in Euroclear. This makes entry into bond indices that insist on Euroclear settlement difficult.

Even if settlement is allowed in domestic clearing houses, the process is cumbersome for foreign investors. One of the biggest concerns among investors over the years was accessibility

To allay such concerns, the Reserve Bank of India introduced a fully accessible route (FAR) in 2020, under which foreign investors and institutions can invest in Indian bonds without any restrictions and investment caps.

Further, the government is not willing to exempt foreign investors from capital gains tax because it would be discriminatory for domestic investors.

BENEFITS TO INDIA

The benefits of inclusion in global bond indices are many. It makes investment decisions easy and that results in a steady stream of foreign inflows into domestic markets.

Passive funds tend to allocate investments to a specific market based on indices and such funds are stable. Further, inclusion in global indices would strengthen a key investor base: foreign institutional investors. 

FIIS provide the much-needed liquidity and churn in the domestic bond market. The overall share of foreign investors is still low and the local bond market is dominated by domestic banks.

Greater participation would mean that bond yields could be kept in check and the RBI may not have to face the dilemma of stepping in as a buyer to reduce the government's borrowing cost.

A steady flow of dollars also keeps the exchange rate from depreciating too much.India Global bond index inclusion is indeed a salivating prospect for India. But the key to cash in on investor optimism is to hasten the process of inclusion.