India Bonds Set to Join EM Bond Index

The most widely followed emerging markets (EM) local currency benchmark will undergo its biggest reconstitution since China's inclusion in 2020, when India joins the index next year. After several years of discussions about possible inclusion, J.P. Morgan announced that certain local currency bonds issued by the Indian government will begin to be added to the GBI-EM suite of indices at the end of June 2024. In the GBI-EM Global Core Index, India's weight will increase by 1% each month until it reaches a 10% weight, where it will be capped.

India's bonds would increase the index yield by 5 basis points, based on September 29, 2023 prices and assuming full inclusion. The duration would increase by approximately 0.04. Regional exposure will become more tilted towards Asia, with Latin American country exposure being reduced slightly more than EMEA exposure.

Impact of India Inclusion

Source: J.P. Morgan. As of September 29, 2023.

India has the second largest bond market among emerging markets, second only to China, and is rated investment grade by all major rating agencies. The reason for its lack of inclusion until now has primarily been the operational hurdles and investment restrictions that made access to the market by foreigners prohibitive. In particular, account opening procedures, trading operations and timely currency repatriation have been cited as concerns. J.P. Morgan’s index only includes countries that are accessible to foreign investors without restrictions. India does impose a withholding tax, however tax hurdles alone, if reasonable, do not make a country ineligible.

India introduced "Foreign Accessible Route" ("FAR") bonds in 2020, which are only available to foreign investors and can be invested in without investment limits, and since then has made substantive reforms to address operational hurdles to foreign investment. Only FAR bonds that meet liquidity criteria and have an amount outstanding of at least the equivalent of $1.0 billion are eligible for inclusion. Currently, there are 23 bonds with an aggregate market value of $330 billion that are eligible.

India enters the index against a positive fundamental backdrop. In 2Q 2023, the economy grew at a 7.8% growth rate, driven by increased domestic demand. After improving earlier this year, inflation has recently increased due to higher food prices. However, inflation is expected to drift back to within the Reserve Bank of India’s target range and the central bank is expected to maintain rates for now. India has a strong demographic profile, and as the world’s most populous democracy benefits from political stability and a growth-friendly policy agenda. In particular, the economy has undergone rapid digitalization in recent years, propelled by government investment including a digital identification system, national payments network, and a buildout of infrastructure that provides the population with access to low cost data. These investments are driving economic growth, as well as higher tax revenues, benefiting the country's fiscal position. A more digitalized economy can also encourage more efficient spending, both in the private and public sectors. In equities, India has seen significant foreign inflows this year thanks to the impact of these tailwinds on corporate profits, and according to Goldman Sachs, the country is the biggest overweight in Asia portfolios among EM money managers.

Index inclusion is expected to result in $20-$40 billion of inflows in the near term, and $180 billion over the next decade, according to S&P. Currently, foreign investment in India's bond market is very low at less than 2% due to the historical obstacles that existed. Foreign ownership will increase from this low base, providing the government with a new source of financing and potentially support for further development of the domestic market. These inflows may also result in lower borrowing costs. Given the relatively high level of government debt, the country's budget deficit and high investment needs, this would be welcome. Lastly, foreign inflows may provide support for the local currency.