The financial markets are set to enter a new phase starting in July with the inclusion of Indian bonds in the JP Morgan Index. Since the announcement of this inclusion in September, there has been a gradual increase in holdings of government securities (G-Secs) by foreign portfolio investors (FPIs). The assets under custody of sovereign bonds held by FPIs have risen from $19 billion in September to $28 billion in mid-June. This indicates that some investors have been building their positions in anticipation of the inclusion in the index.
The JP Morgan index will assign a weight of 10% to India, increasing by 1% per month, which will attract passive investment in Indian bonds. The Reserve Bank of India (RBI) has also included several securities under the FAR banner, allowing for no limits on FPI holdings. This is expected to bring in additional inflows of $20-25 billion, resulting in potential purchases of around `1.8-2 trillion.
As the demand for Indian bonds increases, prices are likely to rise, leading to lower yields in the market. This will benefit banks holding these securities, as they can make mark-to-market gains. Additionally, lower yields in the G-Sec market will lead to a gradual decline in interest rates in the corporate bond market as well.
The influx of foreign funds into the market will also have a positive impact on the forex market, strengthening the rupee and counteracting the strength of the dollar. However, the RBI will need to manage these inflows to prevent excessive currency appreciation and maintain export competitiveness.
There may also be collateral impacts on the equity market due to increased foreign investor interest in India. Overall, the immediate effects of these inflows are expected to be beneficial. However, the RBI will need to monitor and manage the situation to prevent volatility in the currency and bond markets, as well as potential impacts on monetary policy. In FY24, we have observed instances where the yield curve exhibited different behaviors based on the tenure of the securities. Shorter tenures were influenced by liquidity factors, while longer-term securities were impacted by Federal Reserve actions. This resulted in more decisive movements in securities covered by the index, due to concentration effects. The influx of funds into specific securities may lead to skewed demand not only in terms of holdings but also in trading activity, which warrants closer monitoring in the upcoming months.
The inclusion of bonds in global indices has become a reality, thanks to the efforts of the government and the Reserve Bank of India. This development adds a global dimension to a market that was previously predominantly domestic. While this presents various advantages, it also means that there will be increased scrutiny from market participants, particularly in terms of fiscal policies. This is because most deficits eventually translate into Government Securities (G-Secs) that enter a market that is now more globally interconnected.
– Madan Sabnavis, Chief Economist at Bank of Baroda. (Views expressed are personal)