government bonds: Gilts to shine brighter from tomorrow

JP Morgan will include 27 fully accessible Indian government bonds in its GBI-EM global index suite starting June 28, allowing global investors to deploy funds in these bonds.

Inclusion in a bond index means a steady allocation of capital to Indian bonds from an international set of fund managers who are mandated to track the index. India is expected to reach a maximum weight of 10% in the GBI-EM Global Diversified Index over a ten-month period, according to JP Morgan.

Since September 22, 2023, when JP Morgan announced India’s inclusion, foreign investments worth $10.5 billion have flown into fully accessible Indian government bonds which are to be included in the index. Market players estimate flows worth at least $20 billion more in the next 10 months.

Foreign ownership in corporate bonds, too, has risen by a little more than $1 billion since September. Ahead of June 28, the market grapevine is abuzz with speculation over the quantum of flows that may gush in on the day itself, especially as foreign investors have purchased government securities worth over a billion dollars over the past ten days alone.Meanwhile, banks have swung into action as the long-awaited development opens up new business opportunities for them.”We are focused on onboarding a large number of funds that are looking to deal in government bonds via direct access, spread across real money, sovereign wealth funds and pension clients,” said Anita Mishra, head of markets and securities services at HSBC India. “We’ve held roadshows across markets like the US, London, Hong Kong and Singapore in the last six months, meeting interested investors.”The significant demand from foreign investors has pushed down government bond yields, with Standard Chartered Bank expecting the 10-year bond yield to drop 24 points to 6.75% by the end of September. Bond prices and yields move inversely.

Given that government bond yields are the benchmarks used to determine corporate bond yields, highly-rated Indian firms are also likely to benefit, going ahead.

“With a larger section of global asset managers now getting engaged in Indian fixed income markets, we have started seeing increased interest in the corporate bond space as well, as some of these investors look to go beyond IGBs into local credit,” said Siddharth Bachhawat, head – markets at Barclays India. “Setting up FPI sub-accounts, custodian services and operational workflows has already been done for IGBs – they are now looking to leverage this for corporate bonds.”

The RISKS
The Reserve Bank of India has traditionally been wary about opening up the government bond market to foreign investors, especially as episodes like the ‘taper tantrum’ of 2013 caused an exodus of overseas funds, causing sharp depreciation in the rupee and a surge in bond yields. This explains why talks between index managers and domestic authorities continued for 10 years before JP Morgan made its announcement.

“Basically, when the foreigners come into the country, they are going to be looking at the macros of the country, the financial system’s stability… They are going to monitor it very carefully,” said G Mahalingam, former RBI executive director. “If they get some doubts…there could be sudden stops in inflows or there could be gushing outflows, which we saw in the 2013 taper tantrum episode.” For the central bank, a key focus would be the impact of steady dollar flows on the rupee’s exchange rate and the liquidity in the banking system.

The RBI, which may not want the Indian currency to become an outlier amongst peer currencies, is likely to absorb a large portion of the dollar flows, check the rupee’s appreciation, and ensure export competitiveness, experts said.