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Source: The post on India’s inclusion in Global Bond Index has been created on the article “Caution: The watch word for bond index inclusion” published in “Live Mint” on 30th November 2023.
UPSC Syllabus Topic: GS Paper 3 Indian Economy – Indian Economy and issues relating to mobilization of resources.
News: The article discusses the pros and cons of India’s recent inclusion in Global Bond Index.
JPMorgan announced in September that India would be included in its Global Bond Index GBI-EM Global Index suite starting 28 June 2024. However, neither RBI nor the Centre has been overly enthusiastic about it.
What are Global Bond Indices?
Global bond indices include emerging debt markets that closely monitor local currency bonds that are issued by governments of various developing nations.
When a country’s government bonds are added to one or all of these indices, they can get a safe entry into the buy zone of foreign portfolio investors. This enhances the liquidity and ownership base of the bonds.
One such global bond index is the JPMorgan Govt Bond Index-Emerging Markets (GBI-EM).
What are the pros of India’s inclusion in a major global bond index?
- Expansion of investor base for Government Security: An expansion of the investor base for Govt-Securities will improve the govt’s fiscal situation.
- Strengthening of Rupee: Appreciation of Indian Rupee due to an influx of dollars in the economy (the dollar will require conversion to the rupee, thereby increasing its demand).
- Increased Capital Inflows: With India’s inclusion in the index, additional inflows to the tune of $20-25 billion are expected.
- Lower Borrowing Costs: Inclusion in global indices will reduce bond yields and can lead to lower borrowing costs for the Indian government and corporates.
- Less Risk: Investments expected are in rupee-denominated securities and hence not that risky (compared to dollar debt).
India has sufficient forex reserves and RBI has a track record of handling large-scale inflows and large-scale outflows to manage any associated risks. However, the move requires close consideration due to the following reasons.
What are the cons of India’s inclusion in a major global bond index?
Risk of Capital Flight: According to the RBI Governor, there are lots of passive investors who are mainly influenced by the weightage in the index. Any reduction in India’s weightage, for reason such as, say, the government’s refusal to toe a line laid down by major Western powers, could see an exodus of funds from the country.
Risky dependency on foreign funds: The risk of being held hostage to the whims of foreign funds (often subject to political pressures, as we saw in the context of Russia’s ouster from Western capital markets).
Pressure on Forex Market: As holdings will be converted into foreign currency for withdrawal from India, enormous pressure will be built on our relatively thin forex markets.
Depreciation of the Rupee: A sudden bulk demand for dollars would put downward pressure on the rupee, resulting in its depreciation. This will have further implications such as:
a. Inflation (as oil imports become costlier).
b. Increase in current account deficit (as import bills swell).
c. Increase in fiscal deficit (as the government is compelled to subsidize petroleum products that become costlier).
Apart from this, reasons given against a move to more capital account convertibility apply to GBI inclusion as well. This includes factors such as:
Vulnerability to External Shocks: It makes a country more susceptible to volatile international financial flows. Sudden inflows or outflows of capital can destabilize the economy, leading to currency volatility, financial crises, and macroeconomic instability.
Impact on Domestic Industries: A sudden influx of foreign capital can impact domestic industries. For example, it may lead to the appreciation of the domestic currency, making exports more expensive and imports cheaper, potentially harming local industries.
Thus, India should approach this inclusion with caution, taking the risks into consideration.
Question for practice:
India’s bond market may undergo a sea change after its inclusion in global bond indices. However, it should be careful of its downsides. Explain.
