Will adding Indian debt securities to global bond indices reduce yields? Kotak MF's Lakshmi Iyer gives her take

#bondsmdebt, #invest, #yield, bonds, Kotak Mutual Fund

If a country’s bonds are included in debt market indices run by global index makers, it acts as a guide for foreign investors to invest in Indian securities.

Morgan Stanley says it expects India to get included in global bond indices by next year. In a recent report dated September 8, 2021, it says that the GBI-EM (Global Bond Indices – Emerging Markets) and Global Aggregate Index could include Indian government bonds in its index. The actual inclusion could happen as early as in the first quarter of 2022.  The report explains that such an inclusion can bring in huge foreign flows to domestic debt markets – especially to Government securities (G-Secs).

Now, foreign investors have been investing in Indian bonds and equities for many decades now. However, these are done by active fund managers, who choose to invest in global markets as per their own analysis and outlook. But if a country’s bonds or equities are included in global indices, then global passive funds are also compelled to invest in such securities. So, there would be more fund flows to such securities. Besides, India restricts foreign flows into bond markets. But Budget 2020 opened certain government securities for investments from foreign investors. This move paves the way for such bonds to now be included in global indices

In an interaction with Moneycontrol’s Jash Kriplani, Lakshmi Iyer, chief investment officer-debt, Kotak Mutual Fund, decodes how such an inclusion can benefit debt markets. Edited excerpts:

What do you think makes India’s case stronger for inclusion in a global bond index?

Indian rupee is not fully convertible. Therefore huge inflows and outflows from foreign investors could have had the potential of destabilising the currency. However, India is now quite comfortable as far as foreign exchange reserves are concerned. This is a significant turnaround from 2013, when we were struggling on the foreign exchange reserves front. If you look at the fiscal deficit, the current account deficit, both these important indicators have inched lower. This is, of course, excluding the pandemic year, which was an exception. I think these factors, along with our domestic yields being higher than the Western world, would have made our case stronger.

Listen: Simply Save | What could India’s inclusion in global bond index mean for debt investors?

How does this inclusion impact domestic yields on G-Secs and therefore Gilt funds?

It may not necessarily lead to more stable yields, as that would depend upon both the inflows and outflows. We will have to wait and watch on how yields get impacted, but we can possibly have a downward momentum on the yields with increased inflows. Foreign investors that make their investment allocations as per the global benchmarks will also rush to allocate to India’s bond market, as it gets included in such a benchmark. This possible rush to buy India’s bonds can push bond prices upwards, which would result in yields remaining low. But we have to wait and see how this happens.

What could it mean for the overall economy? Will it have an impact on interest rates?

We still don’t know what exactly India’s weight in the benchmark would be if the inclusion happens. But let’s say it brings in approximately $15-20 billion worth of annual flows into Indian bond markets. This can help in bringing down the central government’s fiscal deficit. It can improve the currency outlook and therefore have a positive impact on the current account deficit. All of this can create a virtuous cycle. It can bring down the average cost of borrowing for the government and, subsequently, one can logically extrapolate that it would bring down cost of borrowing for corporate India, which adds to the overall economic growth.

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