JPMorgan announced on Friday that Indian Government Bonds (IGBs) would be included in JP Morgan’s GBI-EM indices1, including the widely used GBI-EM (emerging market) Global Diversified Index. Inclusion will begin with a 1% weight in June 2024, gradually increasing to the maximum 10% weight by March 2025.
The IGB market is the second-largest bond market within EM (after China), and the only country to have an investment grade rating, but not be included in a major bond index. JPMorgan have had IGBs on a watch list for inclusion since 2021, following India’s introduction of the FAR (Foreign Accessible Route)2 program in 2020. The stumbling block for inclusion up until now had been related to tax, but this inclusion looks to have happened without India’s commitment for a change in the tax set up. Currently, 23 IGBs with a combined notional value of US$ 330 billion are index eligible for India to reach the 10% weight in the index3.
Impact of inclusion for India and the rest of EM
Despite the size and liquidity of IGBs, foreign holdings of government bonds have been among the lowest within EM4, suggesting significant opportunity for an increase in the years ahead. Goldman Sachs estimates that India’s inclusion could prompt passive inflows of around USD 30 billion and then another USD10 billion in active flows given IGB’s relatively high nominal yields of around 7%, combined with relatively low volatility5.
These inflows should lead to a decline in IGB yields and strengthening of the currency, although there are some potential headwinds, such as the rise in crude oil prices and India’s rice export ban. Over the medium term, inflows should help finance the country’s fiscal and current account deficits, while the diversification in the investor base should deepen and broaden the bond market and could potentially lower the government’s debt financing bill, without risk of crowding out by the government. Over the longer term, we can expect the cost of capital to come down, helping to finance greater investment and potentially, economic growth.
Once India reaches its 10% weight, Asia will likely represent just under 50% of the GBI-EM Global Diversified Index. According to JPMorgan, China and Indonesia should maintain their 10% weights in the index, while Mexico, Malaysia and Brazil should see their weights go below 10%. The largest reductions in weight include Thailand, South Africa, Poland and the Czech Republic. Meanwhile, India’s inclusion into the GBI-EM Diversified Index should increase index yields by 8bps (and 33bp for the GBI-EM Global Index) and duration by +0.24 years, upon completion of the staggering process6.
Investing in IGBs
As active managers, Capital Group has been investing in IGBs for well over a decade. India has and continues to be an attractive bond market for us to invest in given the size of the bond market and broad economic progress. More recently, we have seen inflation easing back towards the target and the government gradually moving towards fiscal consolidation. As well as offering attractive yields at different stages of India’s economic cycle, our positioning in IGBs has contributed to diversification and lower volatility.
The impact of India having high domestic ownership has generally resulted in reduced volatility as the market has been less prone to shifts in international capital flows. The composition of foreign ownership has also influenced market risk and return characteristics. Within the overall lower foreign ownership of bonds, there has been a higher percentage of non-dedicated EM debt investors compared to dedicated EMD investors. This has acted as an effective diversifier within our local currency debt strategy.
Some of these technical factors are likely to change with India’s inclusion, but Capital Group’s strong research capabilities will allow us to continue to offer investors an effective way to navigate such dynamic market conditions, and the opportunity to capture returns more efficiently by exploiting the opportunities that India’s inclusion to the index will create.
1. JP Morgan Global Bond Index – Emerging Markets.
2. The Foreign Accessible Route allows foreign investors to invest in Indian government bonds without restrictions
3. Source: Capital Group. As at 22 September.
4. Foreigner ownership of IGBs is 1.85%. Source: Morgan Stanley. As at 22 September 2023.
5. Source: Goldman Sachs. As at 22 September 2023.
6. Source: JPMorgan. As at 21 September, 2023.