India Joins Local EM Debt Indices

At the end of June, Indian government bonds joined J.P. Morgan’s GBI-EM suite of local currency indices in the most significant reconstitution since China’s inclusion in 2020. After several years of discussions with regulators and the index provider, and the foreign investor community to address operational issues, approximately $400 billion worth of bonds were included with a 1% weight, which is expected to increase by 1% per month until reaching a maximum of 10%. The bonds entering the index are issued by the Reserve Bank of India (RBI) under the Fully Accessible Route (FAR) for non-resident investors, which do not have investment restrictions. Inclusion may attract a broader base of investors by bringing more attention to the country’s local debt market, and it is estimated to drive approximately $30 billion worth of passive inflows. This is in addition to about $11 billion worth of inflows that occurred prior to index inclusion since the announcement last October. We believe that increased participation of foreign investors may provide additional support to the country’s economic progress.

High Growth, but High Debt

India’s strong GDP growth has made it a standout in the global economy. At the same time, however, the country has run elevated fiscal deficits and accumulated significant debt. Government spending on subsidies, social welfare programs, infrastructure projects, and interest payments on previous borrowing have led to a persistently high deficit. This worsened after the COVID-19 pandemic, driving the deficit to its historical peak. As the pandemic’s impact lessened, economic activity resumed, businesses reopened, and consumer spending increased, the latter of which became a major catalyst for higher Goods and Services Tax (“GST”) collections (more on this later).

Persistent fiscal deficits has led to significant debt issuance. At 82.5% of GDP, India has one of the highest public debt levels among emerging markets. But, one can argue that India’s strong economic growth can support its fiscal spending and high debt levels. Nonetheless, debt investors should continue to monitor the country’s fiscal policies, particularly following President Modi’s narrower-than-expected victory which may impact the potential for reform. Indian bond yields increased by the highest amount in eight months following the election outcome. However, this was short-lived, and S&P Global Ratings raised its rating outlook for India to “positive” from “stable” in May saying they expect growth momentum and fiscal stability to continue regardless of the election outcome, supporting the agency’s constructive outlook on India’s credit profile. The increased foreign capital into domestic debt markets may also provide additional flexibility to finance the government’s ongoing fiscal priorities.

A Rising Digital Power

India’s advancements in digital technology have driven impressive levels of financial inclusion (approximately 90% of residents over 18 have accounts with financial institutions vs. 20% a decade ago).¹ Increased financial inclusion can have a positive impact on the country’s economic profile by bringing more activity into the formal economy. The Unified Payments Platform (UPI) has been one of the most crucial pillars of India’s digital payments growth, as it has allowed for efficient electronic payments, even for those without a debt or credit card. Amid the COVID-19 pandemic and aided by the Indian government’s push for cashless transactions, UPI transactions surged significantly, boosting economic activity within the country. Importantly, this has also driven a significant improvement in tax compliance and transparency. It is now easier for the authorities to track and collect taxes since the digital transactions in the system provide a clear economic activity record. As these digital payments increasingly become a part of people’s lives, the process of economic formalization continues to benefit from better transparency and a broader tax base. India’s GST collections are currently expected to grow at more than 7% monthly over the current fiscal year, which provides new revenue sources for continued investment in infrastructure and other projects, as well as support to the country’s credit profile.

India’s Goods and Services Tax Collections Are Surging

Looking Ahead

India’s inclusion into J.P. Morgan’s GBI-EM suite marks an important milestone in its financial history by increasing foreign investor participation in the country’s domestic bond market, albeit in a limited way. The country’s advancements in digitalization have proven effective in increasing financial inclusiveness efforts and tax revenues. Along with impressive economic growth this has provided support to the country’s ability to maintain its spending and debt levels. However foreign bond investors and rating agencies will continue to monitor for signs of progress in achieving the government’s stated goals to narrow its fiscal deficit in coming years.

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