The decision by JP Morgan to include Indian government bonds in its Global Bond Index has sparked considerable discussion about its implications for financial flows and India’s economic landscape. With the inclusion slated to begin in June 2024 and fully implemented by March 2025, this move highlights both opportunities and challenges for India. Let’s delve into what this development means for India’s financial markets and the broader economic trajectory.
India’s inclusion in JP Morgan’s Global Bond Index, which has an asset under management (AUM) of $236 billion, is expected to attract approximately $23.6 billion in foreign portfolio inflows. This is a notable development, as India’s share in the index will be 10%, representing a significant milestone in integrating India into global financial markets.
READ | Echo chambers of bias: How media shapes gender justice in India
Such inflows are undeniably beneficial in the short term. They provide the Indian government with access to cheaper capital, potentially reducing borrowing costs. Research indicates that foreign portfolio investor (FPI) holdings in Indian government securities (G-Secs) could rise from 1.4% as of March 2023 to 4.1%-4.9% by March 2025 if other global bond indices also follow suit. This would mark a significant leap, though India would still lag behind other Asian economies in terms of foreign ownership of local currency sovereign bonds.
A medium- to long-term perspective
While the immediate inflows are significant, the long-term implications could be even more transformative. A higher share of FPI ownership in government securities can lead to enhanced liquidity, improved market depth, and reduced borrowing costs for the government. Additionally, the inclusion in global indices is expected to bolster investor confidence, signalling India’s commitment to fiscal discipline and macroeconomic stability.
However, challenges remain. India’s bond market is relatively small, with a total fixed income market size of $1.3 trillion, compared to Japan’s $11 trillion or the US’s $51.3 trillion. This size disparity limits India’s ability to attract substantial allocations from large pension funds and asset owners, which typically prefer deep and liquid markets.
Lessons from Japan: A cautionary tale
Japan offers a compelling case study on the perils of an overgrown bond market. With a debt-to-GDP ratio of 252%, Japan has the highest such ratio globally, trailing only Sudan. This unsustainable fiscal burden underscores the importance of balancing growth in the bond market with fiscal prudence. By contrast, India’s debt-to-GDP ratio stands at 81.6%, reflecting a more disciplined fiscal approach.
India’s decision to maintain a smaller bond market is a strategic choice. While it limits the immediate inflow of foreign capital, it avoids the pitfalls of excessive borrowing. India’s sound macroeconomic fundamentals, including a robust forex reserve and controlled fiscal deficit, provide a strong foundation for sustainable growth.
The inclusion in JP Morgan’s index will inevitably attract hedge funds, which thrive on arbitrage opportunities. While these funds provide liquidity, their speculative nature could introduce volatility into the Indian bond market. Policymakers must remain vigilant to mitigate potential risks, ensuring that short-term speculative flows do not destabilise the market.
Beyond Global Bond Index
India’s inclusion in global bond indices, while significant, is just one piece of the puzzle. To attract meaningful long-term investments from global pension funds and asset owners, India must diversify its financial instruments. Private asset classes, including private equity, infrastructure investments, and private debt, hold immense potential.
India’s private asset market is growing rapidly, supported by world-class managers like the National Investment and Infrastructure Fund (NIIF). These markets offer attractive opportunities for long-term investors seeking stable returns. Unlike the fixed income market, which remains relatively small, the private asset market is poised for significant expansion, making it a critical avenue for financing India’s capital needs.
Financing India’s green transition
India’s ambitious green transition, with a commitment to achieving net-zero emissions by 2070, requires an estimated $1.3 trillion in investments. Financing this colossal undertaking through government bonds alone is neither feasible nor advisable. Instead, India must leverage private capital markets, international partnerships, and innovative financing mechanisms.
India’s inclusion in global bond indices is a milestone that underscores its growing stature in global financial markets. However, the journey ahead requires a balanced approach. While welcoming foreign inflows, India must prioritise fiscal discipline and focus on developing alternative asset classes to attract long-term investments.
The road to sustainable growth lies not in emulating countries with oversized bond markets but in crafting a unique strategy that leverages India’s strengths. By fostering a robust private asset market and maintaining fiscal prudence, India can meet its capital needs while safeguarding its economic stability. This is the path that will ensure India’s success in the global financial arena.
(This article has drawn from a presentation by Osamu Yamamoto, CEO of Unison Capital Management Pte Ltd, at an online event organised by EGROW Foundation.)