The Time Press
Opinion

India must go slow on joining global bond indices


“The Reserve Bank of India (RBI), together with the government, is making efforts to enable international settlement of transactions in government Securities through international central securities depositories.” That was RBI governor Shaktikanta Das in September 2021, delivering the keynote address at the annual event of FIMMDA-PDAI (Fixed Income and Money Market Dealers Association) – (Primary Dealers Association of India). The assurance was seen as part of the ongoing process to widen the pool of potential investors and incorporate local bonds into global bond indices.

Fast forward to 10 February 2022, to the governor’s press conference held immediately after the announcement of the statement of the Monetary Policy Committee. In a first, the governor, in response to a question on whether the RBI had any reservations on the inclusion of G-Secs in a global bond index, admitted that inclusion could be a double-edged sword.

For investment banks, especially foreign investment banks, that have been waiting expectantly at the prospect of generous (exorbitant?) management fee and commissions on India’s inclusion in global bond indices, this must have come as a rude shock.

Ever since finance minister Nirmala Sitharaman announced in her Budget speech of February 2020 that the government was considering opening up certain categories of bonds to foreign investors without any cap, inclusion of G-Secs in global bond indices was taken for granted – a question of ‘when’ rather than ‘if’.

After all, the narrative from investment banks seemed convincing enough. Inclusion in global indices would open India’s bond market to more investors and potentially reduce the government’s borrowing costs. India’s inclusion in global bond indices is likely to draw as much as $250 billion of inflows over the next decade and reduce the cost of borrowing by as much as 50 basis points for the government, forecast Morgan Stanley.

To a cash-strapped government, faced with an uphill task of raising money to finance fiscal deficits in excess of 6% of GDP, the prospect of such a plentiful flow of potentially hot money was sufficiently alluring as to blind it, perhaps, to the downside of such flows.

A downside that finally found expression in the governor’s utterance at the post-policy press conference. The truth is the potential long-term cost of attracting hot money flows need to be weighed against the short-term gain of attracting large inflows. There’s little doubt overseas investors will come flocking. The response to the RBI’s Fully Accessible Route (FAR) under which foreign portfolio investors (FPIs) could purchase G-Secs without any limit is evidence of their interest. Of the sum of 1.50 trillion offered by the RBI under the voluntary retention route (VRR) as part of FAR, a sum of 1,49,995 crore had been availed as on 10 February 2022. (The limit has now been raised to 2.50 trillion).

Publicly, what is holding up inclusion is the issue of waiver of capital gain taxes that non-resident investors are seeking (this would disturb the principle of parity with domestic investors). The widely accepted belief is that once that is resolved and negotiations are completed with EuroClear for settlement of Indian bonds, inclusion would follow.

However, governor Das’ admission is the first hint that there is much more at stake. Inclusion in a global bond Index would expose us to all the perils of passive index-based investment, wherein any change – even extraneous – would subject us to wild fluctuations in flows. Take, for instance, the massive bond sell-off witnessed in global markets on Friday, 11 February 2022, following publication of record high US inflation (7.5%) in January. The resultant outflow of funds from all emerging markets (including India) impacted our forex market, with the rupee crossing 75 to the dollar. But the bond market was not affected. Yields on the benchmark 10-year G-Secs closed at 6.7%, scarcely budging from the previous day’s close. The story would have been entirely different if India were part of the global index. There would have been mayhem in both bond and forex markets.

That apart, there is the question of what do we do with such inflows? Do we have enough bankable/viable projects where we could deploy these funds? What about the implications for our exchange rate? Do we want the rupee to appreciate/render our exports uncompetitive? Sure, the RBI can add to its burgeoning reserves, but what happens to rupee liquidity (and inflation) when it pumps in rupees in exchange for dollars?

All these need to be carefully thought through before we get carried away and go in for easy options. Inclusion in global bond indices could give us a sugar high, but like all such highs, has a downside. Our macro fundamentals must be sound enough to take the highs with the lows. We are not there yet.

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