Bond Market: A Turning Point for the Indian Bond Market: What’s in it for You?

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Union budgets are an opportunity to make ballistic declarations. While all of these statements are dissected down to the last word or number by the frantic media on Budget Day, they are then forgotten in no time.

Historically, beyond the theater, Budgets have rarely delivered to the field. As a result, over time, budgets have become a large, but imprecise exercise. But over the past couple of years, something seems to be looking up in earnest, especially after the current team took control of the North Block. Of course, the initial slips were scary for this team. This refers to the regressive start to 2019. After that slippery start, the team seems to have gone very high on the learning curve.

One may wonder why we are talking about budgets when the next one is in several months. Because the history of the bond market and the 2020 budget are closely linked. Here’s how.

To attract capital flows to the bond market, the 2020 budget announced a program that allows foreign investors to purchase unlimited amounts of selected government bonds through the Fully Accessible Channel (FAR). This was a major policy change whereby the government sowed the seeds for India’s inclusion in the global index. On March 31 of that year, RBI quickly followed suit by notifying a special series of G-sec under “fully accessible road”.

In response to the notification, the Ministry of Finance tweeted, “This will significantly facilitate non-resident access to Indian government securities markets and facilitate inclusion in global bond indices. ”

Now, over a year later, that prospect seems near and real. In 2022, according to Morgan Stanley, India will likely be added to global bond indices, bringing one-time index entries of over $ 40 billion in 22/23, followed by annual flows of over $ 18 billion over the course of the year. of the next decade. It should be music to the ears for the India Bulls in the long run.

Beyond the billion dollar streams that make the headlines, we believe this will have far-reaching implications in three broad macro areas listed below.


Cost of capital


It is a well-known fact that India’s public debt to GDP is at a high level compared to its emerging market peers. It represents more than 85% of the GDP. Given mounting fiscal pressures, government borrowing is unlikely to decline anytime soon. So far, public debts have been mainly financed by Indian banks through the SLR (statutory liquidity ratio) mechanism. With a significant increase in government bonds over the past few years, the RBI has had to come to the rescue in many auctions due to the increased supply of government papers. This kept yields above policy rates (spread of about 2.8 percent on a rolling 12-month basis). This is precisely where the inclusion of the index will do its magic.

With a new demand for papers from foreign funds (index funds), yields can follow key rates much more closely and, thus, structurally lower the overall cost of capital. By some estimates, foreign ownership of G-sec could increase to over 9% by 2031 from the current level of 1.9%.


Currency stability


India has historically recorded a current account deficit of around 1.8 percent of GDP (over the past 10 years). This is unlikely to change in the years to come. Although the management of the BOP (balance of payments) has never been a challenge due to the inflows of REITs and FDI, the opening of the Indian bond market will help to diversify the sources of capital in a gradual manner and, thus , will bring more stability and strength to India. rupee. Most brokerage firms now expect the overall balance of payments to remain in surplus in the range of 1.5 to 1.7 percent of GDP over the next 10 years due to the inclusion of the index. This means that we can continue to see an increase in foreign exchange reserves.


Investments and Capex


As previously pointed out, India’s public debt, so far, has been mainly financed by Indian banks through the SLR mechanism. This means that public spending and public investment crowded out private investment. Now, with the opening of G-sec to foreign funds, this creates an opportunity for the RBI to reduce the SLR window in the future and thus make more capital available for private investment. For a capital-strapped country like India, this means enormous potential for investment-driven structural growth.

In conclusion, more than anything, by opening government securities to foreign investors, one sees India’s growing confidence in overall macro stability in terms of price (inflation and currency), fiscal policy (government spending) and monetary policy. (interest rate) . In our opinion, this is the biggest takeaway from this other reform measure for this administration. At the same time, it is also important to stress that this openness should provide the necessary discipline to the administration / development of current and future policies by rewarding or punishing respectively pro-growth or regressive policies.

Future governments will need to think not twice, but several times, before committing to slippery (regressive) policies. This is a huge structural advantage for long term growth. Interesting moments to watch !!


(ArunaGiri N is Founding CEO and Fund Manager at TrustLine Holdings. The opinions are his)


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