About 4 weeks back, on 21st Sept, the Global Research Team at JP Morgan published that India would be included in the index GBI – EM GD (Emerging Market Index – Global Diversified) starting June 2024. The team had identified 23 GOI bonds with a combined notational value of $330 billion as eligible for inclusion in the index which had an AUM of $213 billion. At a cap of 10% this implied a little above $21 billion would flow in the bonds starting 28 June 2024 till 31 Mar 2025 – a staggered inflow of 1% over 10 months.
JP Morgan has two similar products in this bracket – GBI EM Global 10/1 and GBI EM Global 10/0.25. A perfunctory overview of both the products description shows the difference is in the floor. The former has a floor of 1% while the latter 0.25%. Right now it is not clear which one is pertinent to India. Secondary data is thin. Let us hope, for our sake, we never have to find out. Moving from the cap to anything lower would mean an outflow of billions of dollars – proportionate to the delta times the AUM. Happy to kick this problem down the road.
The reaction
The reaction was immediate. Markets (and the commentators) loved the development and the yield of the benchmark 10-year bond 7.18% GS 2033 fell to 7.09% on the back of soaring prices. Unfortunately, the exuberance didn’t last long and as on 18 Oct 23 the YTM was at 7.3488% (Yields are inversely related to bond prices).
Part of the reaction may also have been led by the excitement at the possibility of being included in the much bigger (7X) FTSE Russell Emerging Market Global Bond Index (EM GBI). As the table below shows, inclusion in one may well lead to inclusion in the other.
How did we get here?
Foreign investors purchase of Indian bonds have been lukewarm the last 2 years. As of 2Q23 they held about 1.6% of the market amounting to $19 billion of which $12 billion was issued under FAR scheme. This may well be the game changer.
While there was no official communication, at least two of the members from the PM’s Economic Advisory Council – Mr Sanjeev Sanyal and Dr Sajjid Chinoy – found the development significant enough to speak about it. However, unlike the commentators, both were circumspect about the impact of this momentous event.
The government had started making serious effort for inclusion of GOI bonds in the indices a few years back. There are 3 Emerging Market Indices of note – The JP Morgan Index, the FTSE Russel Emerging Market Government Bond Index, and the Bloomberg EM Index. Inclusion in an index is a big deal for a country since it implies inflow of billions of dollars from passive funds which replicate the index. For countries that have a fiscal deficit and/or current account deficit, the inflow is great news.
Going back a couple of years, the effort started with the RBI’s move to allow Fully Accessible Route for investment by non-residents in government securities. The FAR regulation essentially meant that for specific identified G-Sec, there would be no upper limit to investment amount. Right now, RBI has a list of 31 G-Sec eligible under the FAR scheme. JP Morgan has identified 23 from this set that would be eligible for inclusion in its index.
Impact of Inclusion on the Economy
Bond yields – expected to go down and lower government’s borrowing costs.
Corporate borrowing costs – likely to go down as these are usually benchmarked against government bonds.
Rupee – inflows are also expected to make it easy for the government to finance its current account deficit and reduce the pressure on rupee.
Investor base – diversification from current domestic players (banks and insurance companies companies mostly) to passive investors
Offsetting FDI Inflow – the last few years the FDI has averaged between $40 bn to $50 bn. However, as a % of GDP, there has been a downward trend as the graph below illustrates. An inflow via inclusion in bond index is expected to offset the fall to an extent.
Equity markets – unlikely to have significant impact.
Impact of Inclusion on the Retail Investor
Buy & Hold investor – no impact if your strategy is to hold on to the bonds till maturity. Your coupon is not effected.
Active investor – The trifecta of higher interest rates for longer, strong dollar and high crude prices make it impossible to predict the slope of the yield curve when the inflow of FPI starts from June 2024. Entry and exit strategy would require continuous monitoring of the bond prices / yields
Mutual Fund investor – keep an eye on the returns and the movement of NAV between June 2024 and March 2025. Your fund manager should be able to take positions along the yield curve and mitigate impact. However, if you need to exit your fund during this time, you may need to be light-footed on the timing.
New purchases – could demand possibly be greater than supply of the index-included G-Sec in the secondary market during the 10-month window? It may be one aspect to consider.
What is the worst-case scenario?
The announcement of inclusion was met with considerable excitement and hope that inclusion in one index would pave the way for inclusion in the other two indices – FTSE Russell and Bloomberg. However, that didn’t happen – at least not with FTSE Russel. A week after the JP Morgan announcement, FTSE Russell, in their annual country classification review, said “India would be retained on the Watch List for potential upgrade to Market Accessibility Level ‘1’ and for consideration for inclusion in the FTSE Emerging Market Bond Index”. It is significant that India has been on the watch list since Mar 2021. FTSE has pointed to the following areas as areas of improvement in the G-Sec market structure:
Efficiency of FPI registration
Operational issues related to
Settlement cycle
Trade matching
Tax clearance process
FTSE reiterates its ongoing dialog with RBI and market participants regarding their experience of the evolution of the market structure.
The good news is the issues highlighted are related to operations and not a reflection on the Indian Economy per se.
The FTSE Russell EMGBI market value stood at $1472.9 billion as of end of Sept 2023. Each country’s weight is per market capitalization and capped at 10%. With FTSE Russell EMGBI market value being approximately 7X that of JP Morgan Emerging Market Index, inclusion in the FTSE Russell index would definitely be the game changer.
I have found no recent update from the Bloomberg EM Index
So, with FTSE out of consideration in the near future, the inflows in the bonds would happen only from inclusion in the JP Morgan Index. Right now, this amounts to about $ 21 billion. If Bloomberg follows FTSE, then the only way this amount will go up is if the AUM of JP Morgan’s Index goes up. Otherwise, the inflow could stabilize at $21 billion by Mar 2025.
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