In today’s Finshots, we simplify India's inclusion into JPMorgan's Global Bond Index.

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The Story

India has massive ambitions. It wants to become a $5 trillion economy in the next few years. By 2025, it wants to add over 30,000 km of highways, 400 Vande Bharat trains, over 200 airports and double our port capacity. By 2030, it plans to leapfrog Japan and Germany to become the third-largest economy in the world. However, to get there, the government will need to invest massive sums of money across the board. It needs to spend, spend and spend some more.

Now the government funds its expenses primarily through taxation. But that’s not always enough. More often than not, it will have to borrow money from investors to keep things chugging along. For the longest time, the government has raised money by issuing bonds. Bonds are standardised contracts. The government issues these contracts with a little help from the Reserve Bank of India (RBI). Investors buy these bonds by lending money. And after some set period of time, the government redeems the bond by paying investors some extra money on top.

However, most people who subscribe to government bonds in India happen to be domestic investors ― people from within the country. And this poses an interesting challenge. If you pool all domestic investors together and put them in a room, you can account for all the capital available. This is the money they can theoretically invest. But if everybody chooses to invest most of their capital in government bonds, what will the private sector do?

They will have to compete with the government and they can only do this if they are offering better returns to investors when they borrow money. This strains their financials. So if the government could borrow from foreign investors, that would help everyone in the ecosystem. It would help the government. It would help the private players. And it could help us boost our credibility in the international financial ecosystem.

So can’t foreign investors buy Indian government bonds?

Well, yes and no. For the longest time, the government did allow foreign investors to buy these bonds, but they had restrictions on the amount of bonds they could buy. And there’s one other thing. When foreign investors buy government bonds, they have to convert  “dollars” to “rupees” and then invest that sum in India. However, the government also controlled this conversion business. So you could say that they couldn’t invest freely.

But over the last 4–5 years, there’s been a change in thinking. The government has come to realise that foreign investments can greatly help India achieve its massive ambitions. They also recognised an opportunity. Foreign investors don’t usually like to invest in individual government bonds directly. Instead, they like to buy baskets. Baskets of bonds from many countries. And there are specialised entities that help these investors track the performance of government bonds across the world.

For instance, JP Morgan has created a basket called the Emerging Markets Bond Index. Here, they measure the performance of international government bonds issued by emerging market countries like India. And yet India didn’t feature in their basket or index. They believed Indian government bonds didn’t meet the stringent requirements they set out. So any investor out there who intended to build a portfolio of government bonds would routinely leave out Indian government bonds. Because fund managers were interested in tracking the performance of the index JP Morgan or similar other entities put out. And it didn’t have Indian government bonds on it. So we missed out on a lot of foreign investments.

However, we’ve been working with entities like JP Morgan to meet these stringent requirements. We have been working on removing investment limits for foreign investors. We have been trying to simplify our tax regime. We have been telling them that we wouldn’t interfere with our currency as much. So they won’t have to worry about converting dollars to rupees anytime they want. And after a bunch of promises and actions backing them, it seems finally, they’ve seen merit in including Indian government bonds on their emerging markets bond basket.

A couple of days ago, 23 Indian Government Bonds (IGBs) worth about $330 billion made it to JP Morgan’s Emerging Market Government Bond Index. These bonds will be included slowly starting June 2024 until they form 10% of the total index 10 months later.

In simple words this means, a lot of foreign fund managers who want to replicate or benchmark their performance against JP Morgan’s index will start buying Indian government bonds. And experts believe this could attract as much as $20 billion in foreign capital. Even more, if other entities like Bloomberg or FTSE Russell start including Indian government bonds in their global index.

The obvious upside is that this makes it easy for the Indian government to borrow money. It could also make capital available for private entities in India since the Indian government won’t just have to rely on domestic investors. The flip side is that foreign capital can move out just as easily as it came in. So if billions of dollars worth of foreign capital moved out in a short span of time it could put the RBI in a vulnerable position since these investors will all want to exchange rupees for dollars. And the RBI has to make sure that nothing bad happens to our currency and through it, the economy.

So yeah, at the moment it seems both the government and the central bank believe that the benefits outweigh the risks and we hope that this paves the way for India’s inclusion in the broader financial market.

Until then…

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