A decade ago, India faced one of its most severe balance of payments crises, resulting in a significant depreciation of its currency and earning it the dubious distinction of being one of the ‘Fragile Five’ nations. Fast forward to 2023, a series of gradual policy reforms have paved the way for India to expand its influence in the global financial landscape and deepen its integration into the global financial system. A significant milestone in this journey was reached on September 25th, when JP Morgan announced its decision to incorporate select Indian government securities into its emerging market indices. This announcement marks a “material” event for the Indian bond markets.
Historically, foreign investor participation in the Indian markets has been lackluster, if not virtually non-existent. However, the suggested inclusion of Indian government securities could usher in a substantial influx of US$25 to 30 billion (approximately Rs 2.5 lakh crore) over the next 18 months.
The financial markets have been abuzz with speculation about these potential inclusions, and the confirmation has already had a positive impact across the yield curve, with heightened trading activity in long-term bonds. As of the time of writing, the benchmark 10-year G-Sec stood at 7.10%.
Passive trackers linked to the aforementioned indices manage around US$250 billion. The phased approach to inclusion implies a monthly inflow of US$1.5 to 2 billion into the 23 identified bonds. This influx is expected to elevate India’s standing on the global stage and fortify its economic fundamentals. It’s anticipated that the Reserve Bank of India (RBI) may engage in sterilization operations during this inclusion period to bolster forex reserves and stabilize the currency.
Building on this success, the government may consider introducing additional bond series, creating opportunities for long-term debt capital to fund India’s extensive infrastructure and development requirements. Since these bonds are denominated in rupees, currency-related risks are expected to be limited.
This development marks a significant victory for India’s policymakers, and the markets have rightfully celebrated the announcement.
Looking ahead to the medium term, once the noise surrounding potential Fed rate hikes and global yields subsides, it’s believed that market rates may have peaked, and yields could gradually decline. From a demand perspective, active foreign funds may incrementally increase their investments, possibly less than $5 billion before the index inclusion.
We have maintained a bullish stance on the macroeconomic front, considering the challenges the RBI faces in hiking rates due to expected lower inflation. The main concerns have revolved around global yields and oil prices. However, global yields are approaching their peak, and further rate hikes by the Fed are not anticipated.
From a strategic perspective, we have extended our portfolio duration within the respective investment mandates. This decision was driven by macroeconomic considerations, not solely in response to the inclusion news. We anticipate that our duration strategy will yield benefits in the medium term.
Investors may seize this opportunity to bolster their exposure to duration products, with a structural allocation to short and medium duration funds, while tactically considering GILT funds.
