Global bond market indices still exclude India, but
the country could take its place in the benchmark in 2022—with far-reaching
implications for bonds and beyond.
India has one of the world's fastest-growing
economies and a population second only to China. But you wouldn't know this
looking at global bond indices. Unlike most major emerging markets, India has
no presence on any of them.
The market consensus holds that India will be
added—eventually—pending unanswered questions around timing, implementation and
size. Morgan Stanley Research has a different take: Its economists and
strategists believe that global-bond-index inclusion is imminent.
“India has made significant strides in
macroeconomic stability, and its government is more motivated than ever to encourage
corporate-investment-driven growth," says Chief India Economist Upasana
Chachra. “We think India will be included in two of the three major global bond
indices in early 2022."
Beyond the direct benefits of index inclusion—it
could trigger $170 billion in bond flows over the next decade, lifting Indian
bond prices while lowering borrowing costs—this milestone could have profound
implications for the country's currency, corporate bonds and equities.
“India would be the last major emerging-market country
to join the global bond indices, following China's path two years ago,"
Chachra says.
Here are four implications of global-bond-index inclusion for India, and why it could signal the emergence of a new India.
Immediate Boost for Government Bonds
Major indices don't simply track their respective
markets—they influence them. When an index adds new constituents, portfolios
pegged to those benchmarks must adjust their allocations accordingly. “India's
inclusion would trigger significant index-related inflows, followed by an
allocation from active global bond investors," says Min Dai, Head of Asia
Macro Strategy.
For example, if added, India could represent 9.2%
of the JPM GBI-EM Global Diversified Index, making it the second-largest
country in that benchmark, after China.
In its base-case outlook, Morgan Stanley estimates that $40 billion would flow into Indian government bonds following inclusion into 2-of-3 global indices —Bloomberg Global Aggregate Index and JPM GBI-EM Global Diversified Index—with $18.5 billion in annual inflows over the next decade. This would push foreign bond ownership, currently less than 2%, to 9% by 2031. As more foreign capital flows into Indian government bonds, the yield curve—or difference in short-term and long-term yields—could flatten by 50 basis points, or hundredths of a percentage point.
Shrinking Deficit, Stronger Rupee
Index inclusion, while significant on its
own, would also signal policymakers' desire to support higher economic growth
through investment. “This will push India's balance of payments into a
structural surplus zone and indirectly create an environment for lower-cost
capital and, ultimately, be positive for growth," says Chachra, adding
that India's consolidated deficit could shrink to 5% of its GDP by 2029, down
from 14.4% for the 2021 fiscal year.
India’s currency would also feel the impact. The
shrinking deficit could bolster the value of the Indian rupee by 2% a year
against a basket of other major currencies, in exchange rate terms. While
India's long-term 4% annual inflation would imply a 2% depreciation in the
value of the rupee in nominal terms, at around a 6% yield, Indian government
bonds could offer investors medium-term returns of around 4% in dollar terms,
“which is quite attractive for foreign investors," says Dai.
Corporates Come Out of Obscurity
Inclusion in global bond indices could also help
Indian corporations with their capital needs. When foreign capital flows into
government bond markets, it lowers overall borrowing costs, improves debt
sustainability and also drives demand for other—read corporate—fixed-income
securities. That's potentially good news for India's domestic corporate bond
market, which foreign investors have largely overlooked.
Given its status as Asia’s second-largest economy,
“India is 'punching below its weight',” says Dai, noting that India’s
corporate-bond-market size as a percentage of GDP is closer to much smaller
countries like Thailand and the Philippines.
Foreign investors would gain access to a
significantly larger pool of Indian corporate issuers. To put it in stark
terms: The closely followed universe of dollar-denominated offshore Indian
corporates comprises 57 issuers, while India’s domestic market has nearly
2,000 issuers, half of which still lack a credit rating, all of which gives
potential investors many more opportunities to spot mispriced bonds.
History suggests that index inclusion can help bring domestic-only corporates out of obscurity. “We think that India's current situation is similar to China in 2017, when it started opening its onshore bond market to foreign investors," says Dai. “As ownership of Chinese government bonds increased, we also started seeing an increase in foreign ownership in the China onshore corporate-bond market."
Equities Buoyed by Better Growth
The opening of India's sovereign bond market may
also bode well for equities, which stand to benefit from lower borrowing costs
and a healthier macroeconomic backdrop. Among these, large private banks could
be the most obvious winners. Still, nonbank financials— such as those focused
on mortgages, credit cards, insurance and asset management—could enjoy the
spillover effects of a more robust bond market in India.
