The inclusion, a first for the country, could lead to billions of dollars of inflows into local currency-denominated government debt and bring down bond yields, while also providing some support for the rupee.
About 73% of benchmarked investors voted in favour of India’s inclusion, JP Morgan said.
Why did the inclusion happen now?
The Indian government has broached the subject of the inclusion of its securities in global indexes as far back as 2013.
Restrictions on foreign investments in domestic debt held that discussion back.
In any case, there is little direct impact expected on the equity markets.
In April 2020, the Reserve Bank of India introduced a clutch of securities that were exempt from any foreign investment restrictions under a ‘fully accessible route’ (FAR), making them eligible for inclusion in global indices.
Currently, 23 Indian Government Bonds (IGBs) with a combined notional value of $330 billion are index eligible, JPMorgan said.
What are the inflows looking like?
JPMorgan said Indian bonds will eventually hold a weight of 10% in its index, following 1% additions to its weightage each month from next June.
The inclusion could result in inflows of close to $24 billion over this 10-month period, analysts estimate, significantly higher than the $3.5 billion invested by foreign investors in Indian debt, this calendar year.
Foreign holdings of outstanding bonds could rise to 3.4% by April-May 2025, from 1.7% currently, analysts estimate.
Is this good news for the Indian rupee?
Larger debt inflows from next financial year will make it easier for India to finance its current account deficit and reduce the pressure on our currency.
$24 billion worth of index inclusion-related inflows will come way to cover a part of India’s estimated current account deficit, for the next financial year.
Impact on yields and borrowing
India’s fiscal deficit remains high at a targeted 5.9% of GDP for the year ending March 31, 2024, which will result in the government borrowing a record 15 trillion rupees (app. $181 billion).
Banks, insurance companies and mutual funds have been the largest buyers of government debt.
This additional source of funds will help cap bond yields and the government’s borrowing costs.
Traders estimate the benchmark bond yield will fall 10-15 basis points to 7% over the next few months.
Corporate borrowers will also benefit as their borrowing costs are benchmarked to government bonds.
Increased foreign flows will also make the bond and currency markets more volatile and could push the government and central bank to intervene more actively to regulate any dramatic changes.