Caution is the watchword on India's inclusion in any global bond index | Mint

Caution is the watchword on India's inclusion in any global bond index

There is a very real danger of our macro policies being held hostage to foreign funds keen to dictate terms.  (ANI)
There is a very real danger of our macro policies being held hostage to foreign funds keen to dictate terms. (ANI)

Summary

  • The RBI Governor is right to be wary of Indian bonds being included in a JPMorgan bond index from the middle of next year. As a double-edged sword, its risks require close consideration.

It’s a double-edged sword. …As you well know, there are lots of passive investors who are mainly influenced by your weightage in the index," said Reserve Bank of India (RBI) Governor Shaktikanta Das, speaking at a finance industry conclave in late October 2023. Elaborating on the pros and cons of India’s inclusion in a major global bond index (GBI), Das added, “The reverse can also happen. When your weightage goes down, the passive funds will automatically move out, or when there is some other development globally happening, there can be outflow of funds." This was the first ‘official’ reaction from a central bank that has all along studiously avoided any comment on India’s GBI inclusion up ahead. And it was long overdue. Foreign brokerages have been lobbying hard for India’s inclusion in the index, publicly holding out the carrot of additional inflows to the tune of $20-25 billion while privately anticipating the lucrative commissions that will doubtless follow.

Governor Das could not have put it better. The reality is that all the reasons that militate against a premature move to capital account convertibility apply almost entirely to GBI inclusion as well. This is often glossed over on the grounds that the investments expected are in rupee-denominated securities and hence not so risky for us. This is to miss the wood for the trees. It is true that to the extent global money flows into rupee bonds, the risk of being held hostage to the whims of foreign funds (often subject to political pressures, as we saw in the context of Russia’s ouster from Western capital markets) is less than with dollar debt. But the difference is only of degree. Any reduction in India’s weightage in the index, for some extraneous reason such as, say, the government’s refusal to toe a line laid down by major Western powers, could see an exodus of funds from the country. To the extent that liquidated holdings will be converted into foreign currency for withdrawal from India, enormous pressure will come to bear on our relatively thin forex markets, with huge negative repercussions for us. A sudden bulk demand for dollars would put downward pressure on the rupee, resulting in depreciation of the domestic currency, with implications for a host of macro fundamentals, ranging from inflation (as oil imports become costlier), India’s current account deficit (as import bills swell) and the Centre’s fiscal balance (as the government is compelled to subsidize petroleum products that become costlier) to interest rates as the Indian bond market reacts to a sudden fall in demand.

There is thus the very real danger of our macro policies being held hostage to foreign funds keen to dictate terms, as seen in a few countries like Indonesia. The lure of ‘cheap’ short-term funds could yet tempt some future government to borrow abroad, rather than choose the politically unpopular option of tightening its belt. For now, though, it should reassure us that neither RBI nor the Centre has been overly enthusiastic about JPMorgan’s announcement in September that India would be included in its GBI-EM Global index suite starting 28 June 2024. True, we have sufficient forex reserves and that “RBI has a track record over the years and especially in the recent period, of handling large-scale inflows and large-scale outflows," as Das said. But as we have seen—and hopefully learnt—from forex crises across the world, when markets freeze, a big treasure chest may not prove sufficient. It is important, therefore, that we stay cautious.

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