Inclusion of Indian bonds in JPMorgan bond index to have limited impact on Indian bonds, rupee, says ASK Wealth

Even though the inclusion of Indian Government Bonds (IGBs) in JPMorgan’s Bond Index may lead to inflows of billions of dollars into the country, the move may not have a significant long-term impact on the bond yields and domestic currency, according to a report from ASK Wealth Advisors Private Limited.

"The inclusion into bond indices is good to have, feeds incrementally into the “Bharat shining” narrative. It’s also a good sandbox regulatory experiment for RBI, to manage monetary policy while losing some policy-making flexibility. However, there is no material impact on bond yields. The determining factor for that will be global, especially US policy rates," said ASK Wealth Advisors in a note.

As Mint reported earlier, JPMorgan will include Indian government bonds in its widely tracked emerging market debt index which may lead to inflows of billions of dollars into India. India's local bonds will be included in the Government Bond Index-emerging markets (GBI-EM) index and the index suite, benchmarked by about $236 billion, in global funds.

Many experts hailed this development and said bond investors will have more options now for investments. It will also pave the way for the bond market to grow its roots in India. Moreover, it is also positive news for the domestic currency as it will lower India’s cost of funding and help India finance its fiscal and CAD or current account deficit.

Also Read: How will the inclusion of Indian government bonds in the JPMorgan EM debt index impact rupee, bonds? Here's what experts say

ASK Wealth Advisors has a contrarian view. The financial firm believes this inclusion is good for sentiment but may not have a material impact on bond yields and the Indian rupee.

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Yields unlikely to move materially

The financial firm pointed out that the total stock of outstanding IGBs today is around ₹100 lakh crore, or $1.2 trillion and a flow of $20-25 billion is a "veritable drop" in the ocean on this stock.

"Assuming a 10-12 per cent growth in nominal fiscal deficit for FY25 (when these flows are expected to materialize), the government will issue IGBs worth ₹17 lakh crore in that year. Ergo, the expected flow of $20 billion, or about ₹1.65 lakh crore, will be less than 10 per cent of the gross borrowing for the year. Above all, this flow is only a one-off adjustment to index weights," said ASK Wealth Advisors.

"Ongoing flows – and markets discount ongoing expectations rather than one-offs – are going to be a lot lesser, dependent on investor flows into emerging market (EM) bond funds benchmarked to JPM GBI-EM GD Index. Markets price investments based on expectations of ongoing changes, not one-offs. Given the uncertain (and small) nature of the former, yields are unlikely to move materially," the financial firm added.

Also Read: India’s inclusion in JPMorgan’s bond index needs sober analysis

ASK Wealth observed that FPI (foreign portfolio investor) active bond investors have not really found India to be too attractive

on a consistent basis. Despite being a nudge, the inclusion of IGBs into an index will hardly make wholesale changes to their strategies. It said the bigger opportunity is in passive funds, which merely track the index and hence have mechanical flows.

Limited impact on the rupee too

ASK Wealth underscored that by current trends unless oil prices collapse, we are likely to run a CAD (current account deficit) of about $100 billion for the year.

"A $20 billion flow, while nice at the margin, won’t move the dial, especially as the flow is one-time instead of structural – longer-term flows are dependent on EM bond flows," said the financial firm.

However, it may provide some more support to the Indian rupee (INR) which has been doing quite well. ASK Wealth pointed out that while the Indian currency has depreciated against the US dollar, it has appreciated against most developed market (DM) currencies.

"Outlook for the Indian rupee is positive, with one-year forward spreads at near-record lows (about 2 per cent). Again, a $20 billion one-off is nice to have, but there isn’t really a need for a one-time confidence capital right now. Rupee's outlook, therefore, doesn’t really change," said ASK Wealth.

Also Read: Expanding CAD poses risks to rupee

IGBs not so attractive for investment

ASK Wealth finds IGBs as a weak investment opportunity. The financial firm observed that India’s monetary tightening has been remarkably mild, in the face of sharp increases in global tightening, especially US Fed. As a result, the spread between Indian and US 10-year yields is at an all-time low.

"This denotes a richly valued asset class for foreigners, not a relative value opportunity. While passive funds will still invest – they have no choice, active investors are unlikely to find massive opportunities in India risk-adjusted spreads to merit large incremental allocations," said ASK Wealth.

Another key factor that the financial firm pointed out is that RBI the increased demand for IGBs will be offset by an equivalent supply of IGBs by the RBI to mop up the excess liquidity created.

ASK Wealth explained when we get foreign exchange (say USD) in INR-denominated assets/use cases, banks convert USD into

INR, which causes the INR money supply to go up. Higher-than-expected money supply pushes inflation higher. Therefore, to the extent we get ₹1.65 lakh crore of incremental FPI debt flows next year, RBI is likely to sell bonds to absorb the material excess liquidity created by the same.

"In effect, the incremental demand for IGBs will be offset by a near equivalent incremental supply of IGB to mop up the excess liquidity created," said ASK Wealth.

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