Significance and Challenges of International Government Bonds

Source: The post incorporating government bonds into global indices has been created, based on the article “Exposing India’s financial markets to the vultures” published in “The Hindu” on 3rd February 2024.

UPSC Syllabus Topic: GS Paper 3 – Indian economy- mobilization of resources

News: Significance and Challenges of International Government Bonds, In September 2023, J.P. Morgan announced the inclusion of Indian local currency government bonds in its GBI-EM index from June 2024, a significant step for India’s financial market. Following this, Bloomberg Index Services in January 2024 proposed adding India’s FAR bonds to its index. Now, the focus shifts to FTSE Russell, which has kept India on its watchlist for a potential upgrade, highlighting the anticipation of reforms in India’s government bond market by global investors.

What initiatives has the Indian government taken to incorporate government bonds into global indices?

Introduction of the Fully Accessible Route (FAR) in 2020: This allowed foreign investors to invest in a segment of government bonds without constraints.

Engagement with Global Index Providers: India’s discussions with major index providers like J.P. Morgan and Bloomberg have been pivotal. J.P. Morgan announced the inclusion of Indian bonds in its index in September 2023, followed by Bloomberg in January 2024.

Report by RBI’s Inter-Departmental Group in 2022: This outlined the strategy for integrating Indian LCGBs into global indices and the internationalization of the rupee.

Negotiations on Policy Challenges: India has been addressing issues such as capital gains taxes and local settlement to make its bonds more attractive to international investors.

What is the significance of incorporating government bonds into global indices?

Attracting Foreign Investment: Incorporating Indian government bonds into global indices opens the door for significant foreign investment in India’s bond market.

Reducing Borrowing Costs: This move can lower the cost of borrowing for India. The influx of foreign funds into Local Currency Government Bonds (LCGBs) tends to reduce domestic interest rates.

Facilitating Financing: It aids in financing India’s fiscal and current account deficits by attracting institutional investors with long-term investment horizons.

Internationalizing the Rupee: It’s a step towards making the Indian rupee a globally recognized and used currency, as shown by RBI’s initiative to integrate LCGBs into global indices.

Mitigating “Original Sin” Problem: By borrowing in local currency, India mitigates the risk associated with borrowing in foreign currencies, which has historically led to financial crises in emerging economies.

Note: Original sin, a concept coined in 1998, refers to the inability of a country to borrow foreign debt in its own currency. This leads to currency mismatches on the balance sheet, especially in developing countries. It affects a country’s exchange rate, increases debt costs during economic downturns, and lowers credit ratings, impacting capital flow stability and output volatility.

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What are the issues associated with incorporating government bonds into global indices?

Loss of Financial Autonomy: Including bonds in global indices can reduce a country’s control over its long-term interest rates, making it more susceptible to global financial changes.

Increased Market Volatility: This integration exposes the market to greater volatility, as seen in the aftermath of events like the 2008 Lehman crisis and the 2013 US Federal Reserve policy shift.

Risk of Rapid Capital Outflow: In times of crisis or uncertainty, foreign investors may quickly withdraw, destabilizing the market. Examples include Malaysia in 2014-15 and Türkiye after 2018, where rapid exits of foreign investors led to currency devaluation and reserve losses.

Exchange Rate Risk: Local currency bonds carry the risk of currency depreciation, which can lead to increased costs for servicing debt and potential economic instability.

Way forward

To progress, India must balance attracting foreign investment through bond market inclusion with managing potential financial risks. Learning from Malaysia and Türkiye’s experiences, India should maintain financial stability while advancing the internationalization of the rupee, as outlined by the RBI’s 2022 report.

Question for practice:

Examine the potential risks and benefits of including Indian government bonds in global indices.