JP Morgan India inclusion: What it means for Indian g-secs 

1992 was a landmark year for Indian investors. That was the year when Indian stock markets were first opened to Foreign Portfolio Investors (FPIs). In the 30 years since, the trickle of FPI investments into India have turned into a flood. Today they own 20% of all outstanding shares in the market. But as FPI investments have driven stock prices higher, they’ve contributed to higher volatility too. It is thanks to significant reliance on FPIs that Indian equities catch the flu, every time there’s even a minor disturbance in the US or other Western markets.    

The JP Morgan India inclusion announcement last week, which said that it will include Indian government bonds in its emerging markets index could be a similar watershed moment for Indian bonds. It can open the floodgates of the Indian bond market to FPIs. Here’s what it could mean for you – the fixed income investor. 

The JP Morgan India inclusion announcement

For the last decade or so, there have been recurring rumours that global index providers are looking to add Indian government securities to their benchmark bond indices. But despite parleying by the government, they refused to bite the bait. The reasons cited were many: India has only a BBB- sovereign rating for its debt, RBI restricts how much g-secs foreigners can own, Indian taxation of bond gains is unfriendly, Indian bonds are not available for settlement via Euroclear etc.   

These concerns are yet to be addressed. But with the West sanctioning Russia and Russia dropping out of global benchmarks as a result, global index providers are taking a fresh look at India. JP Morgan, one of the large bond index providers has jumped the gun last week and announced that it was adding Indian government securities (g-secs) to its GBI-EM Global Diversified Index. Indian g-secs will be assigned the maximum 10% weight allowed to any country in this index. This will also result in Indian g-secs making up 8.7% of JP Morgan’s GBI-EM Global index.  

The JP Morgan India inclusion is set to take effect from June 28, 2024. The 10% weight will not be added at one go. Starting June 28 2024, JP Morgan will add a 1% weight in India g-secs to this index every month until it gets to a 10% weight by March 31 2025. That opens up a nine-month window for global investors tracking this index to add India weights to their portfolios. 

But there are caveats. 

RBI imposes a ceiling on foreign investors buying Indian debt and has other conditions attached to their investments too. But global index providers including JP Morgan are willing to include only g-secs without any restrictions, into their indices. In April 2020, RBI opened up a new route for FPI investments in specific g-secs called the Fully Accessible Route (FAR), where FPIs can invest in Indian bonds without ceilings or conditions applying.  RBI has from time to time notified the g-secs that will be under the FAR. 

JP Morgan has specified that only India g-secs available through FAR will be eligible for index inclusion. Within these, only g-secs with at least $1 billion outstanding and 2.5 years of remaining maturity will be included. Therefore, JP Morgan’s final shortlist consists of 23 specific g-secs at present, making up Rs 27 lakh crore in notional value. This list will be revised over time as new securities meet the criteria. Any new issues of FAR g-secs that meet these norms, will also be included in future.  

The list of currently traded FAR g-secs likely to be included in the JP Morgan index is provided below. RBI has said that all future issuances of 7 year, 10-year, 14-year, 20-year and 30-year g-secs will be eligible for FAR. Investors can therefore expect FPI flows into these g-secs too, in future.  

What the JP Morgan India inclusion means

The JP Morgan India inclusion or inclusion of Indian g-secs into global bond indices was eagerly awaited by domestic institutions as it adds a new category of buyers to absorb the never-ending supply of Indian government bonds. As you know, the Indian government runs an annual fiscal deficit (excess of spending over income) of about 4-5% usually, with the figure shooting up to 6-6.5% since Covid. 

Meeting this deficit requires the Centre to borrow rising sums from the market each year. It borrowed Rs 14.2 lakh crore on a gross basis in FY23 and plans to borrow Rs 15.4 lakh crore this year. Today, the Indian government borrows mainly from domestic institutions such as banks, insurers, EPFO, pension funds and mutual funds, apart from retail investors in the direct platform.

To ensure that domestic institutions keep buying g-secs, there are rules like the 18% Statutory Liquidity Ratio (SLR) for banks, minimum g-sec investment limits for EPFO and insurers must make in g-secs etc. But ultimately, even the money available from these institutions comes from Indian savers, who are having to contribute more and more towards the g-sec kitty every year. 

These forced subscriptions to g-secs restrict how much money Indian institutions (and thus savers) can lend to private enterprises or invest in other assets. This problem of perpetual excess supply of g-secs is one of the reasons why g-sec yields in India rule so high. As all other borrowers in the market trade at a spread over g-secs, this leads to interest rates on corporate bonds being high too. 

So here’s what the JP Morgan India inclusion can do to the Indian bond market: 

• Once Indian g-secs are included in global bond indices, the hope is that foreign investors will make Indian g-secs an automatic part of their global and emerging market bond allocations. If foreign investors chip in to buy a significant quantity of Indian g-secs off the market, the excess supply problem could get addressed. Indian institutions and savers will also be freer to allocate more to non-g-sec investments. 
• Once Indian bonds are fully open to global investors, every time g-sec yields shoot up, foreign buyers could appear on the horizon to buy g-secs and prop up their price, thus tempering their yield. 
• So, if foreign investors do take a fancy to Indian g-secs, interest rates in India could head steadily down in the long run. G-sec yields in future rate cycles may never be allowed to top levels like 7.5% or 8 %. It is this expectation that has prompted analysts and brokerages to put out notes saying that Indian 10- year g-sec yields will fall below 7% as these index changes take effect. 

Indeed, if you believe in the India story keeping its stock markets booming over the next 10 or 20 years, the bond story should play out in a similar fashion too. FPI flows into both equity and debt markets, if sustained can lead to a slower pace of Rupee depreciation against the USD. 

How much money will flow due to the JP Morgan India inclusion?

But for Indian bond investors seeking immediate takeaways from the JP Morgan India inclusion, the critical question is: Will FPIs take a fancy to the Indian g-secs? How much money will really flow in? When will it flow in? 

Analyst reports put out by foreign brokerages and asset managers after the announcement peg the inflows into Indian g-secs at between $20 and $40 billion, over 2024-25. Where do they get these numbers? In its press release announcing the India inclusion, JP Morgan said that globally $213 of assets are benchmarked to its GBI-EM Global Diversified Index.

As this index will add a 10% India weight in phases from June 2024, a straight-forward conclusion would be that global funds benchmarking to this index will need to buy about $21 billion of Indian g-secs between June 2024 and March 2025. But this is assuming the $213 billion number refers to passive funds tracking the index. If this includes active funds as well, they may choose to be underweight or overweight India based on their assessment of the economy and its fiscal position. This could lead to flows being lower than the expected $21 billion. 

Some analysts have also stretched their bullish thesis to suggest that now that JP Morgan has bitten the bullet, it won’t be long before other global index providers such as FTSE Russell and Bloomberg may also look at including India into their global bond indices. The FTSE Russell EM Government Bond Index has $1477 billion benchmarked to it, while the Bloomberg Global Aggregate index has over $2000 billion. These guesstimates have prompted some analysts to suggest that Indian g-secs could attract $30 billion from passive investors and another $10 billion or so from active investors.

However, weighed against these rosy estimates, we need to note that FPIs (the active ones) have not been queuing up to invest in Indian bonds, despite FAR, so far. In recent years, FPIs have used up only a fraction of the domestic g-sec ceilings set by RBI. NSDL data on September 26 2023 show that they had used up only 23.5% of the overall ceiling on Indian g-secs allowed to them. Most of their holdings were short-term with only 5.6% of the RBI’s long-term g-sec ceiling utilised. FPI holdings in individual FAR g-secs ranged from 0.2% to about 6% of the amounts allowed to them. 

This goes to show that the only certain flows into Indian g-secs are the passive flows benchmarked to the JP Morgan Bond Index, which could be in the range of $20-21 billion. Given their need to closely track their benchmark, passive investors will peg up their weights in Indian g-secs only when the benchmark composition changes and not ahead of it. Therefore, one can expect these flows to come in between June 2024 and March 2025. Thereafter, any inflows or outflows from the JP Morgan Index will cause FPIs to add or trim allocations in India g-secs. 

At today’s exchange rate (Rs 83.2 to one USD), $21 billion in flows will translate into an investment of about Rs 1.74 lakh crore in Indian g-secs. This would be about 12% of the Central government’s annual g-sec issues. As the inflows will be concentrated in specific bonds, FPIs will be taking up higher proportions of individual g-secs. 

What the JP Morgan India inclusion means to debt investors 

• In past rate cycles, the market yield on Indian g-secs has swung between a low of 6% and a high of 9%. In future, with FPI buying likely to play a role, yields may top out at much lower levels of say, 7-7.5%. 
• Investors looking to play long duration through debt funds should look to lock in at yields of 7% plus instead of waiting for the 8% mark to be hit. 
• In developed markets, interest rates usually head steadily down in the long run. Rising FPI flows into Indian g-secs may cause Indian rates to float down in the long run too. 
• Sustained FPI flows into Indian bonds can prop up the Rupee and slow its rate of depreciation against the dollar in the long run. But global events like a financial crisis can trigger equity plus bond outflows, and lead to sharper Rupee slides during such episodes. 
• India g-sec yields are likely to turn far more sensitive to global news flow as well as rate changes in the Western markets, particularly the US. It may be tough for Indian rates to decouple from global trends as they have done in the last couple of years. 
• Investors in gilt funds, medium duration funds, constant maturity funds etc. which have a significant g-sec allocation should expect higher volatility in their NAV and returns. 
• The FPI eligible g-secs under FAR may see lower yields and better secondary market liquidity, than non-FAR g-secs.