JP Morgan has forecast non-resident holdings of India Government Bonds (IGBs) to nearly double over the next year, from the current 2.5 per cent of outstanding to over 4.4 per cent, with authorities proactively implementing a wide range of measures to help improve the accessibility of the IGB market for foreign investors.
This observation comes even as India is set to become the 25th market to enter J.P. Morgan’s flagship Emerging Market Local Currency Government Bond indices (GBI-EM GD) index from June 28, 2024 (phased over 10 months).
Only bonds classified under the Fully Accessible Route (FAR) will be eligible for index inclusion. Within this subset of IGBs, there are currently 27 Fully Accessible Route (FAR)-designated IGBs which meet the index inclusion criteria.
India bond market reforms
Gloria Kim, Global Head of Index Research - J.P. Morgan, said, “India has made market reforms for investors over the years and now meets index inclusion criteria. These reforms have improved the accessibility and tradability of India’s domestic market for the global investor base, which makes IGBs eligible for inclusion in the J.P. Morgan Emerging Market Local Currency Government Bond indices.
“Assuming an index-neutral position, we expect foreign inflows to be between US$ 20-25 billion following index inclusion, based on the estimated AUM tracking the GBI-EM GD and the expected 10% weight of India in the benchmark.”
Upon inclusion, India will have the single highest duration across the index (at 7.03 years vs Emerging Market/EM Asia’s 5.97 years), with an above-average yield-to-maturity (at 7.09 per cent vs EM Asia’s 3.98 per cent), per JP Morgan’s Global Emerging Markets Research.
Non-resident participation
“Structurally, we see ample scope for non-resident participation in the local bond market to increase, given it currently sits at one of the lowest levels in EM,” JP Morgan said in a note.
It underscored that India’s local debt stock is amongst the largest in EM, with the total outstanding bonds included in the index standing over $400bn (only surpassed by China).
In addition to its large size, turnover in Indian local market instruments is also significant, standing at over $350bn in 2023 (which accounts for over 9 per cent of total EM local debt trading volume).
The phased inclusion of Indian bonds in JP Morgan’s GBI-EM Global index will lead to a sustained demand for the bonds, as funds tracking the index will need to allocate resources accordingly, said Venkatakrishnan Srinivasan, Founder and Managing Partner, Rockfort Fincap LLP.
“As Indian bonds start to be included in the index from June 28, there will be an immediate surge in demand from foreign investors and index funds, pushing bond prices up and yields down.
“Over the 10-month period as the inclusion weight increases to 10%, the continuous demand will help maintain higher bond prices and lower yields,” he said.
JP Morgan analysis
As per JP Morgan’s assessment, the drivers of local bond yields are 1) they still offer value for non-resident investors given the strength of the fundamental macro backdrop; 2) RBI’s policy rate, together with domestic inflation, tends to be the biggest driver of long end bond yields; 3) low levels of inflation volatility have directly fed through to the volatility of local bond yields (which is amongst the lowest in EM).
India’s local bond markets have been amongst the strongest in major EM, delivering positive total returns (in USD terms) in 11 of the past 15 years.
“Gross annualized returns stand at 3.8 per cent since 2010, compared to the 1.1 per cent for the GBI-EM GD Index. On a net of tax basis, the returns stand at 2.3 per cent and 0.7 per cent respectively,” according to the note.
In addition to the favourable return profile, local bond volatility is also amongst the lowest in EM, following the implementation of the inflation targeting framework in 2016, making return-to-volatility ratios compelling (even on an after-tax basis).