September 21, 2021
Entry into global indices could attract US$170 billion in bond inflows in base case, says Morgan Stanley.
Inflows could rise to as much as US$250 billion in a bull market scenario, says Morgan Stanley.
High inflows can push India’s balance of payments into the surplus zone and strengthen the rupee.
Foreign inflows can also anchor inflationary expectations and push economic growth higher.
In the Budget for 2021-22, Finance Minister Nirmala Sitharaman had announced a series of measures to relax barriers for foreign investment into Indian bonds, particularly government securities or gilts. Some of these steps were aimed at getting Indian sovereign bonds listed on global indices, including those operated by JP Morgan and Bloomberg Barclays.
These measures now seem to be fructifying. Last week, Principal Economic Adviser Sanjeev Sanyal had said the government expects listing of Indian government securities on global bond indices within this financial year.
India’s inclusion in JP Morgan’s Government Bond Index-Emerging Markets and Bloomberg Barclays’ Global Aggregate Index could be game changer for the securities market. This could help attract as much as US$170 billion in bond inflows over the next decade in a base case scenario, global financial services giant Morgan Stanley said in a note. It sees the figure rising to as much as US$250 billion in a bull market scenario.
“This would have profound implications for the economy, FX, bond yields and equity markets,” Morgan Stanley said.
In the first year itself, index inflows could be US$40 billion, followed by annual inflows of US$18.5 billion in the following years, it predicts. This could help flatter the yield curve on Indian gilts by 50 basis points, and help Indian currency appreciate by 2% per year in REER (real effective exchange rate) terms, thanks to the productivity improvement.
“A lower borrowing cost could help India’s debt sustainability and foreign inflows into IGBs (Indian government bonds) would prompt more interest in onshore corporate bond markets,” the Morgan Stanley report said.
There will be a ripple effect even on the stock market due to bond inflows’ positive impact on growth and interest rates. “Foreign investments inflow would drive India’s balance of payments position into a structural surplus zone and strengthen the rupee. It will also lead to lower cost of capital and softening of interest rates, resulting in sustainability of debt, and thereby helping India maintain an investment grade rating,” says an article published in the Mint newspaper.
The government has been doing its bit to help with the global bond indices inclusion. “In March 2020, the Reserve Bank of India opened up a window notified as the Fully Accessible Route (FAR) under which ‘specified securities’ would remain qualified for investment under FAR until maturity. All new issuances of government securities of 5-year, 10-year, and 30-year tenors from FY21 will also qualify for investment under FAR as ‘specified securities’,” the Mint report highlighted.
Also, India’s admission of a record budget deficit is drawing praise from investors, who see it as baby steps to making data out of Asia’s third-largest economy less opaque and aiding its goal of becoming part of global bond indices, according to a Bloomberg report soon after the presentation of the 2021-22 Budget. In the Budget, Sitharaman had said the government’s fiscal deficit will touch 9.5% of gross domestic product in 2021-22 from 6.8% a year ago.
Apart from the obvious benefits of high forex inflow, the Morgan Stanley report also underlined some key benefits of the inclusion in foreign bond indices related to external stability, long-term cost of capital, growth, inflation and foreign exchange reserves.
For one, it says that the overall balance of payments may remain in surplus, tracking at 1.7% of GDP in the next 10 years. Also, opening up India’s bond markets could help to provide more buyers for government securities. This will improve the supply-demand dynamics and reduce any undue pressure on the cost of capital. The foreign ownership of central government G-Secs could rise to 9% by 2031 from the current level of 1.9%, the report forecasts.
In addition, the rise in investment rate could create the basis for a virtuous cycle of growth and push economic growth rates higher to an average of 6.5% over the next 10 years.
As far as inflation is concerned, the inclusion in bond indices could help anchor retail-based inflation in the RBI’s comfort zone of 2-6%. Moreover, forex reserves will rise as well. This will, in turn, stave off any external volatility.
On the flip side, one of the concerns raised about any sudden high inflow of foreign investment into Indian gilts has been whether it may increase volatility for the Indian rupee. However, analysts at Morgan Stanley don’t think that it would be a concern for the next few years for two reasons: One, low foreign ownership of Indian gilts compared to other emerging markets. Two, benchmark investors are sticky with less risk of sudden flight to safety.
“Rather, having foreigners being active in a local government bond market could not only improve the liquidity of the market, but also incentivise the government and central bank to be prudent and market-friendly when they make fiscal and monetary policy,” Morgan Stanley said. “This would help a healthy development of local markets in the long term, in our view.”