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Amidst the ongoing frenzy in the stock market, the news about the prospects of Indian bonds getting its due place in the global bond indices have largely gone unnoticed. Global equity investors are on the edge, anxiously waiting for the US Fed to roll back fiscal stimulus or easy money policy. The question is not if but when the US Fed will close the liquidity tap and this action is expected to dry up fund flows, thereby slowing down the soaring prices of equities globally. Many attribute the current frenzy in the global stock markets to be driven by excess liquidity in the financial system which is also evident in the sharp rise of Indian stock indices.

The liquidity or flow of funds from Foreign Institutional Investors (FIIs) that may be potentially lost by the Indian stock market due to tapering off stimulus by the US Fed can be more than compensated indirectly by the proposed inclusion of Indian bonds in global indices. Such inclusions would require fund managers following a passive index strategy to buy Indian bonds to match their weights in the tracking index, thus leading to direct inflows. The inclusion of India’s sovereign bonds in global bond indices such as JP Morgan’s Government Bond Index-Emerging Markets (GBI-EM) and Global Aggregate Index, could possibly pave the way for attracting close to US$170 – USD$250 billion in fund inflows over the next decade as per estimates put out by various global banking majors. This compares favourably with a total US$36.4 bn of foreign funds attracted by the bond market over the last decade. The move to include Indian bonds in the global indices is likely to have profound impact across all segments in the economy

India is among the very few large economies which has remained outside the global bond indices and received negligible investment by foreign institutions. Now the situation is set to change as Indian Government’s bond debut in the global indices is slated for 2022. The returns offered by Indian bonds are far more attractive possessing strong investment grade rating compared to any other emerging market bond in the category given the inherent strength of the Indian economy.

Foreign Investors have been investing in Indian markets but most of the investments were done by active fund managers who choose to invest in these markets because of their analysis and outlook. However, inclusion of a country’s bonds or equities in global indices compels the global passive funds to also invest in securities which brings in huge foreign inflows in the domestic markets. This inclusion in global bond indices could push the government to relax the foreign portfolio limits and open the bond market further. Possibly, the passive flows can go a long way in plugging the gap between the demand and supply for bonds and have a soothing effect on bond yields too.

The Central Government, one of the major beneficiaries of the move to include bonds in global indices can look at bond markets to bridge their budget deficit as well as fund planned expenditure at lower rate of interest , thereby help keep fiscal deficit at manageable levels. With foreign investors ready to invest in Indian bonds, RBI will be more confident of mobilising the funds as and when the government decides to tap the bond market without having to over depend on Indian banks to subscribe the paper. Indian banks too can instead choose to extend higher credit to both individuals and corporates at lower interest rates which in turn can help boost retail consumption and fillip to kickstart capex investment cycle. Increased leverage at lower cost will help corporates report healthy growth in profits which in turn can fuel stock prices. There is enough evidence to support the hypothesis that strong inflows into bond markets will have a positive rub off on equities as well. The performance of the corporate sector and the equity markets depends largely on the economic outlook, stable interest and currency rate regime. Robust bond market and global inflows is expected to help keep the rupee strong and stable, thereby help improve the external balance of payments position and stabilise internal inflationary situation

Hence, we strongly believe that inclusion of Indian bonds in global indices will mark a major transformation of Indian economic landscape and in turn provide necessary stimulus to the markets.

Author – Rishabh Mukherjee, CFA and Payal Mehta, FRM