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The buzz surrounding the inclusion of Indian bonds in global indices is increasing; the net impact may be limited

By on January 3, 2022 0
One month away from the 2022-2023 Union budget, the noise around the inclusion of India’s sovereign bonds in global bond indices is intensifying. India is among the last of the major emerging markets (EM) to be included in global bond indices.

With the second highest stock of government securities in circulation totaling $ 2.3 trillion, the opportunity for investors and borrowers will be significant. Therefore, the inclusion of Indian government securities (GoI) in global bond indices would increase the share of REITs in the specified securities, and therefore in total government debt.

Depending on the weight assigned to India and the global benchmarks in which GoI securities are included, expected inflows could be between $ 10 billion and $ 30 billion. Given that total capital inflows to India have averaged $ 66 billion per year over the past five years, annual inflows due to the inclusion of global bonds could be anywhere between 15-45%.

With such large capital inflows, the INR could easily strengthen to 70 / USD or even fall below, if left unchecked – this is where it starts to get tricky.

It is clear that higher demand for G-sec among foreigners would help raise their prices and lower bond yields. However, at the same time, the INR would have the potential to strengthen significantly against the USD, if left unchecked.

Since the currency and domestic bond markets have an impact on a country’s financial condition index, these two opposing forces (lower yield and stronger currency) would offset each other and the final impact would depend on the extent of each impact – which is difficult to judge at this point. stage.

It also means that this policy would incent (or favor) the domestic sector to the detriment of exporters, which seems to contrast with recent policies. In all cases, the net impact would be less than the gross impact.

The market determined INR, however, is unlikely. Policymakers have shown their prejudice against a strong appreciation or depreciation of the INR, which has remained limited to a range in recent years (except during exceptional periods like March-April 2020). Therefore, to mitigate the appreciation bias of the INR, it is very likely that the RBI will intervene in the foreign exchange market (FX) and accumulate more foreign exchange reserves (FXR).

However, given that broad monetary policy over the next several years would be to reduce excess liquidity and normalize the size of an unusually large RBI balance sheet, higher FXR build-up implies lower selling (or buying). ) of G-sec. As a result, domestic bond yields would not fall much.

The actual impact of including India in global bond indices would therefore be very different when the RBI intervenes compared to the scenario where the RBI does not intervene (see graph below). The RBI’s intervention would not only mitigate the appreciation bias of the INR, but also reduce the likely positive impact on bond yields, as the sale of the RBI would offset additional foreign demand from G- dry.

After banks and insurance companies (CIs), the RBI is the third largest holder of G-sec, accounting for 17% of the country’s outstanding dated government securities.

Moreover, just as the higher foreign ownership of Indian G-sec should bring more fiscal discipline, it is possible that with an additional source of budget deficit financing, the Indian government will feel more confident to support growth rather than to control the budget deficit. . In the first case, fiscal discipline will act as a constraint to higher domestic growth in difficult circumstances, bringing longer-term benefits, while any temporary gain would be offset over time by the lack of fiscal discipline in the economy. second.

Overall, there is a high likelihood that either a) the RBI’s hands-off approach – India being included in global bond indices – would help lower bond yields, but strengthen INR, or b) the intervention of the RBI would ensure that G -secs demand from abroad is matched by the sale of the RBI, so that the INR does not appreciate significantly. Either way, the actual impact on India’s financial conditions would be (far) less than the gross impact. Therefore, the impact on growth may also be minimal or even nonexistent.

What are the likely scenarios when India is included in global bond indices?

(The author is Chief Economist at Motilal Oswal Financial Services)