A report by Morgan Stanley hinted at India being included in the Global Bond index. What does this inclusion mean and how it will change the face of debt capital flows from FPIs into India?
What Indices will include India?
Currently, there are 3 most popular debt market benchmark indices in the world. The JP Morgan GBI is the most liquid and the other two are the Bloomberg bond index and the FTSE Bond Index. For now, it is likely that India would be included in the first two indices but not in the third index by Q1-FY23. That is good enough as it is estimated that the weight given to India would be 9.2%. That is next only to China among the key emerging markets in bond index.
Will it result in big flows
Normally, inclusion in the global indices results in a lot of passive flows as well as active flows. We will come back to this point later. In terms of quantity of flows, it is estimated that $40 billion of flows could come in the first 2 years and $250 billion of flows could come over 10 years. That would be huge considering that the total exposure of FPIs to Indian bonds is just about $19 billion out of the total outstanding bonds of $1 trillion. That is just about 9%. For India, this will reduce the bond holding pressure on commercial banks and RBI to a large extent. After all, FPIs hold equities of $655 billion in Indian capital markets.
What is it about index inclusion?
The numbers look great, but what is so special about index inclusion. One factor is that a large chunk of global flows are passive flows. This applies to equity and debt flows. An inclusion in a key index means that the passive global investors like index funds and ETF funds would automatically allocate money to Indian bonds. That is the starting point. The presence of passive funds also brings in active fund managers as the markets become more liquid and, hence, less risky. Thus, the inclusion in the index, not only boosts passive flows, but also indirectly boosts active flows into India.
Are there are any risks?
Actually, there are a couple of risks and we have seen that in equities. The index inclusion is contingent on India holding its Investment Grade (IG) credit rating. Currently, it is at the lowest level of IG and any downgrade of rating or even outlook could put capital flight pressure. Rupee weakness gets accentuated by debt market outflows and that risk will be pronounced once India is included in the indices. The second risk is too much global ownership of government bonds as it could make the macroeconomy a tad unstable. However, the international experience has been that this normally does not happen. With forex reserves of $645 billion, India has the firepower to manage risks. It is time to take Indian bond markets to the next level now!