The announcement came in September that India would be included in JPMorgan Chase’s ‘Goverment Bond Index- Emerging Markets’ from June 2024. This immediately strikes most people as something of interest, not so much to the man in the street as to the man on Dalal Street. This would be as misplaced as thinking that the World Trade Organisation matters only to traders or that a viral cough and flu in Chinese city affects only the locals.
Global Impact: Beyond Dalal Street
India’s inclusion in a major bond index can enable further intermeshing of local prices, interest rates, exchange rates and job opportunities with global economic developments and geopolitical shifts. It would make more capital available to India and push up the pace of capital formation and growth. It wwould also bring local developments into the focus of greater global scrutiny and amplify the domestice consequances of foreigners’ approval of or displeasure with local politics.
Bond Index Inclusion Mechanics
What does inclusion in a bond index mean? It is a bit like the inclusion of a stock in the set of 30 stocks whose weighted average price gives you the Sensex. Pools of savings, such as mutual funds, come in two types: actively or passively managed. Actively managed funds have the fund manager constantly scanning the universe of opportunities and shifting capital around, selling low-yield securities and buying high-yield ones. Naturally, actively managed funds command higher asset management fees.
Passively managed funds are less demanding of the fund manager’s vigilance, these being invested in the stocks in one or more indices, such as the Sensex or the Nifty. The asset management charges are lower for such funds.
Secondary Market Dynamics: Nimbus AI Analogy
If a stock gets added to the Sensex or the National Stock Exchange’s Nifty, money would flow into the stock, and a stock that is ejected from an index would see funds selling it, depressing its stock price. Take a company that makes lime pickle. If the firm were to offer a public issue today, it would, more likely than not, be called Nimbus AI, that AI being added to give some sub- liminal star power to the com- pany in the eyes of the typical investor who has no clue what artificial intelligence is, but knows it is the flavour of the season on the market.
Once it offers a number of shares to investors and finds enough buyers to make a success of the initial public offering, the shares would be listed. Only the issue price at which investors bought the shares offered in the IPO matters immediately to the promoters of Nimbus AI. If the share price tumbles, it does not take away from the capital they received. If the share price rises after listing, it does not increase the capital they received.
However, developments on the secondary market for Nimbus AI shares have a bearing on how much the promoters can borrow against its shares. The higher the share price of Nimbus AI, the greater the amount the promoters can raise from banks, offering the shares as collateral. This is one benefit from foreign portfolio investors being allowed to bring in additional capital into the stock market. Those who had subscribed to the IPO or bought Nimbus AI shares later can sell the shares at a profit if the share price has gone up. This money is now available in the hands of the seller to make fresh investments in the real economy.
Foreign Capital Inflows: FDI vs. FPI
Both Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) can bring in capital that augments the stock of productive capital in the economy. FDI does the job directly, and the beneficiary company is the investee company. In the case of FPI, the investee company and the beneficiary company would typically be different, and there is no guarantee unless the FPI takes part in capital mobili- sation by the promoter, such as by taking part in an IPO or receiving a private placement of shares that the capital the FPI brings in would actually go into real investment instead of circulating in the financial sphere.
Something similar would happen with the inclusion of Indian government bonds in JPMorgan’s index. Many funds with a mandate to invest in the index bonds would, for the first time, invest in Government of India bonds. They would buy rupee bonds, so there is no increase in external debt. But when these foreign funds exit India, they would need to convert their rupees into dollars, raising the demand for dollars, with the tendency to depreciate the rupee.
When they enter in large quantities, they would tend to strengthen the rupee. This entry and exit could be persuaded by circumstances unrelated to developments in India, such as monetary policy in the US or the European Union, but a stronger rupee could make Indian exports less competitive and a weaker rupee could send the price of petrol at the pump up, because we import the bulk of the oil we consume.
Financial Stability and Yield Dynamics
The Reserve Bank of India and the Finance Ministry would have to work harder, and in tandem, to guard against disruptive currency movements arising from FPI inflows and outflows from the bond market. The job of maintaining financial stability would get harder.
At the same time, to the extent that banks would. have competition from FPI bond investors to buy government bonds, yields could go down when things are going smooth. Additionally, banks would have funds released from holding government debt, now that FPI is holding it to a larger extent than prior to the index inclu- sion of Indian bonds, available to lend to the industry.
Corporate Bond Market Development
India’s market for corporate bonds remains stunted. The JPMorgan move has no direct bearing on this state of underdevelopment, but greater inflows of foreign capital into government bonds, and more widespread adoption of hedging instruments, such as currency derivatives and interest rate swaps, would prepare the ground for developing the corporate bond market as well.
Thus, the inclusion of India in a global bond marketindex would deepen the capital market, make more capital available and place additional demands on the government and the central bank for macroeconomic management. It would also demand good behaviour from domestic political actors to prevent capital flight.
TK Arun is a senior journalist based in Delhi.
The article was first published in The Tribune as Inclusion in Bond Index, With Strings Attached on December 7, 2023.
Disclaimer: All views expressed in the article belong solely to the author and not necessarily to the organisation.
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Acknowledgment: This article was posted by Aasthaba Jadeja, a research intern at IMPRI.