With Entry into JP Morgan Bond Indices, India Is Playing in the World

Why in News?

• JP Morgan has decided to include India in its Government Bond Index-Emerging Markets (GBI-EM) index. The inclusion is scheduled to commence from June 28, 2024.
• Being part of a global bond index can attract foreign investors who use index-tracking funds and passive investment strategies.

JP Morgan Government Bond Index-Emerging Markets(GBI-EM)

• The index was launched in 2005 and is the first comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging Market governments.
• As Emerging Market governments look increasingly toward their domestic market for sources of finance, investors are looking more closely at local markets in search for higher yield and greater diversification.

Procedural Requirements for Inclusion into Global Bond Indices

• There are two other notable global bond indices — the FTSE EM Index and the Bloomberg Barclays EM bond index.
• The procedural requirements and conditionalities are strict and depends upon tackling operational hurdles such as custody and settlement, clarity on taxation and Euroclear. 
  • Euroclear is one of two principal securities clearing houses in the Eurozone which specialises in verifying information supplied by brokers involved in a securities transaction and the settlement of securities transacted on European exchanges.
• Therefore, while being included in JPM Index is great news for India, this inclusion automatically will not lead to India’s inclusion in other indices.

Significance of India's Inclusion in JP Morgan's Emerging Markets Bond Index

• Will Impart a Positive Momentum
  • 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.
  • Nearly two dozen Indian government bonds with a combined notional value of $330 billion will be eligible.
  • Total flows could top $45-50 billion over the next 12-15 months alone once India is part of the third key bond indices.
  • For context, India has received total bond inflows of around $40 billion over the last decade, that is, under 2 per cent of the total issue size.
  • However, actual annual flows may vary, depending on the underlying macro dynamics and momentum of active as well as passive flows.
• Will Provide an Alternate Source of Financing: The inclusion 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.
• Will Reduce Risk Factor: It will structurally help lower India’s risk premia and the cost of funding which has long been a bugbear for borrowers.
• Will Strengthen India’s Bond Market and Currency
  • It will also deepen India’s bond markets, increase liquidity, widen the ownership of G-Secs (Government Security) 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.
• Beneficial for the Corporate Sector
  • 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.
  • Less Pressure on Commercial Banking Sector: The commercial banking sector will face less pressure to absorb a majority of government bonds and hence the balance sheets will have more ability to lend to the needy private sector segments in the economy.
• Will Be Crucial in Building Infrastructure
  • India is currently on its way to building the much-needed infrastructure.
  • This is vital for creating the infrastructure backbone for realising the manufacturing-led growth ambitions.
  • With public debt rising faster than savings, bond inclusion can provide a long-term sustainable source of funding via investing in government assets.

Challenges Associated with the Inclusion of India into JPM GBI-EM

• Hostile External Economic Scenario
  • The timing of inclusion is interesting, asthe external environment has turned more hostile.
  • The 10-year US treasury yield has risen rather sharply, and the US Fed remains aggressive.
  • Yet another US government shutdown approaches, posing a risk to markets. Furthermore, the global trade and geopolitical environment remains unclear.
• Underlying Macroeconomic Scenario
  • The inclusion in the global indices will not make India automatically entitled to huge resultant inflows.
  • The underlying macroeconomic scenario will always matter and there remain challenges that should not be overlooked.
• Spotlight on Government Finances and Fiscal Responsibility
  • 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 with five state elections and then the general election.
  • Rising crude oil prices are causing fiscal problems and any relief via petrol or diesel price cuts or other sops will become tougher.
• Significant Macro Risks: Reliance on foreign funds for funding domestic deficits entails significant macro risks as was seen during the global financial crisis.
• Will Expose Indian Debt Markets to Greater Volatility: 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.
• Can Result in Volatile Currency
  • The Indian government and policymakers have been sceptical of foreign money, since such money can often be hot money.
  • Hot money’s tendency to move quickly from one country to another in search of profits, can result in a volatile currency rate and potentially cause larger financial issues.
  • Excessively high foreign currency inflows can also result in appreciation of the rupee, which could make Indian manufacturers less competitive in global trade.
  • The 1997 financial crisis is a prime example of hot money flows derailing economies of emerging markets.

Way Forward

• Increased Focus on Operational Hurdles
  • Several operational hurdles will need to be addressed like the ability to clear and settle Indian debt on an international platform like Euroclear, repatriation of funds.
  • There will be a requirement of focus on tax complexities including - removing or lowering the capital gains tax compared to what domestic investors would pay.
• Reforms Towards Greater Market Access and Transparency
  • The ongoing reform process, easier market access and transparency will shape and hasten the country’s integration into global markets.
  • Moreover, it will pave the way for a landscape of unparalleled market development, long-term capital inflows, and innovative financial products.

Conclusion

• Intense discussions, preparations and efforts of the government and regulators for nearly a decade have paid off. 
• Inclusion in a global bond index will enhance India’s visibility and credibility in the international financial community.
• By addressing the aforementioned concerns, India would grow as a coveted investment destination and global economic powerhouse.

Q1) What is Government Security (G-Sec)?

A Government Security (G-Sec) is a tradable instrument issued by the Central Government or the State Governments. It acknowledges the Government’s debt obligation. Such securities are short term (usually called treasury bills, with original maturities of less than one year) or long term (usually called Government bonds or dated securities with original maturity of one year or more). In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs). G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.

Q2) What is a Bond?

A bond is a debt instrument in which an investor loans money to an entity (typically corporate or government) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money to finance a variety of projects and activities. Owners of bonds are debt holders, or creditors, of the issuer.

Source: The Indian Express