Home / Opinion / Views /  Pros of India's inclusion in global bond indices don't outweigh the cons

"Nothing," said Victor Hugo, the famous 19th century French writer and politician, "is as powerful as an idea whose time has come." Flip the statement around and, hey presto! What follows is that inclusion of Indian bonds in global bond indices is clearly an idea whose time has not yet come! Otherwise, it would have swept all else before it. After all foreign brokerages, eyeing lucrative commissions and other fees, have been lobbying for months with the government to allow such inclusion.

Alas! Latest news reports suggest the government has (wisely) decided not to act in haste. While reports speak of the government deferring inclusion in the JPMorgan emerging market global index till pending operational issues are sorted out, the decision, presumably, applies to the principle of inclusion rather than to the specifics of a particular index. This is as it should be.

The reality is the underlying rationale for inclusion is not an open-and-shut case. Much like the time some years ago, when there was enormous pressure on India to move to full capital account convertibility — a move India wisely resisted and hence saved itself from the worst ravages of the East-Asian crisis and then the Global Financial Crisis — there are pros and cons to inclusion in global bond indices. And as on date, there is nothing to suggest pros outweigh the cons.

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The pros, if foreign brokerages are to be believed, are that inclusion would open the floodgates to inflows of much-needed foreign exchange, an argument that looks particularly attractive at times like the present when the RBI intervention in defence of the rupee has seen forex reserves deplete at an alarming rate. The size of our G-sec market, at around  80 trillion or $1 trillion, makes investment in government bonds an attractive proposition, especially since the market is liquid and benchmark bonds are widely traded. Estimates speak of inflows to the tune of as much as $250 billion over the next decade.

Second, it would open domestic bond markets to more investors and potentially reduce the government’s borrowing costs; by as much as 50 basis points, forecasts Morgan Stanley. To a cash-strapped government, faced with an uphill task of raising money to finance fiscal deficits well over six percent of GDP, the prospect of such a plentiful flow of (hot?) money could be sufficiently alluring as to blind it, perhaps, to the downside of such flows.

A collateral benefit could be that corporate bond yields will also come down commensurately, as these are benchmarked to G-Secs.

So, what are the cons? Apart from contentious operational issues relating to settlement and taxation, where India has long held that settlements must happen in India and capital gains must be paid as applicable to domestic players so that there is a level-playing field for domestic and international players, there is another, bigger concern. This relates to the nature and quality of the inflows.

Remember, G-secs are nothing but debt instruments of the government. At a time when we have seen all around us the perils of high indebtedness — Sri Lanka, Pakistan et al — any move that puts temptation in the way of governments, present and future, must be eschewed. Emerging market economies that issued international debt in the low interest rate in post-pandemic days are now seeing their bonds trade at a premium of over 1,000 basis points over safe-haven US Treasuries, effectively shutting them out of global financial markets and ruling out any scope to refinance

Inclusion in the index would also expose us to all the perils of passive index-based investment wherein any change — even extraneous — would subject us to wild fluctuations in flows. In February 2022, when global markets witnessed a massive bond sell-off, following publication of record high US inflation (7.5%) in January 2022 and impacted our forex market, with the rupee crossing 75 to the dollar, the bond market remained unaffected. Yields on 10-year G-secs closed at 6.75%, scarcely budging from the previous day’s close. The story would have entirely different if India had been part of the global index.   

Ironically, even as foreign brokerages have been lobbying for inclusion, the reality is that even existing limits for investment in G-secs have not been fully utilised. National Securities Depository Ltd data shows that the outstanding amount in sovereign bonds is around  1.33 trillion, while the foreign portfolio investment limit permitted under the Reserve Bank of India rules is around  3.75 trillion. There is, therefore, nothing inevitable about higher inflows in the event of our bonds being included in global indices.

Remember, one of our major strengths has been that the bulk of our debt is domestically held. Remember also, that foreign portfolio investors are fair-weather friends — in the first six months of 2022, they have already sold more debt than in all of 2021. As the US dollar strengthens in response to Fed tightening and the flight to safe havens gathers pace, selling pressure is bound to increase.

All these aspects need to be carefully thought-through before we allow ourselves to be swayed by easy options. Inclusion in the global bond index is like having a sugar high — could be great for the moment, but like all highs, could have a (huge?) downside. Like with capital account convertibility, our macro fundamentals must be sound enough to take the highs with the lows. We are not there yet.

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