Kotak Insights | Date 29/09/2023
India is on a mission: a mission to hit that coveted $5 trillion economy mark in the next few years.
But guess what?
To fuel this financial rocket, the government will need to shell out monies across the board.
And where does the government get this cash? A chunk comes from taxation, but hey, that’s not always enough. So, here's the magic trick: they borrow from investors.
This is where investment bonds come into play. The government issues these bonds, raises the money it wants from investors, and repays it back with interest.
(Explore tax-free bonds with Kotak Securities. Click here for more.)
But why are we talking about bonds today? Because India has got a seat in a leading global bond market index.
Let us explore it in detail, one concept at a time…
Let’s start with the basics - bonds!
Imagine this: you lend money, and you get it back with a little extra (interest!). Bonds are like that, but on a grand scale. They represent a debt that an investor provides to the issuing entity, often a government or a corporation. In return, they receive regular interest payments and the principal amount at maturity.
The Indian government, with the help of the Reserve Bank of India (RBI), has been issuing bonds for ages. It sells these bonds to investors, and the funds they raise are used for various economic needs.
But the government realised that it isn’t fully tapping into the potential of bond markets. For instance, most of the government bonds are bought by domestic investors and the government misses out on a lot of global funds.
It’s because foreign investors don’t participate in Indian bond issues as it’s a complex process and they would rather pick up a foreign index that makes it easier for them to invest in a basket of bonds and track it.
India wanted in on this action.
For a while, it has been working with entities that have such global bond indexes for its inclusion. It has been working on meeting stringent requirements, removing investments limits, and many such measures.
And it seems the doors are opening wide…
Meet the JP Morgan Global Bond Index
Now there are many entities that help investors track the performance of government bonds across the world. One such index is created by JP Morgan and it’s called the Government Bond Index - Emerging Markets (GBI-EM).
The index measures the performance of international government bonds issued by emerging market countries like India. And yet India didn’t feature in their basket or index. Up until now.
But a couple of days back, JP Morgan said 23 Indian Government Bonds (IGBs) worth about $330 billion are eligible to make it to the GBI-EM.
These bonds will be eligible to be included slowly starting 28th June 2024 until they form 10% of the total index across 10 months.
Now, this is a big milestone because India was the only large emerging economy which was not the part of any emerging market bond index.
In simple words this is like a stock getting included in a major index like Sensex or Nifty.
Pass to the Global Finance Party
Now, when India gets included in this index, it’s like getting a VIP pass to the hottest party in town. Global investors start noticing us, and the funds start flowing in.
This means more foreign investors looking at Indian bonds, resulting in a financial boost and making it easier for the Indian government to borrow money. Cha-ching!
A lot of foreign fund managers who want to invest or replicate or benchmark their performance against JP Morgan’s index will start buying Indian government bonds. Buying will also be seen from global mutual funds or exchange traded funds (ETFs) who want to take advantage of higher interest rates in emerging bond markets.
And experts believe this could attract over $20 billion in foreign capital. Even more, if other major entities like Bloomberg or FTSE Russell start including Indian government bonds in their global bond index.
Plus, it’s a great upside to the government which has been running a fiscal deficit. So, these inflows could lower the fiscal deficit stress for government and lower their borrowing costs.
More funds would also mean a stronger Indian Rupee and a boost to our financial markets.
All this will make Indian macros look good, which will further attract more equity funds.
As for private businesses and companies, the inclusion could lower borrowing costs.
Lower yields (interest rates) triggered by this inclusion could lower capital cost for Indian businesses. That’s a win-win, isn’t it?
Businesses can spend more on capital expenditure, innovate, and also see an uptick in margins.
Lastly, this inclusion will have sector-specific impacts. For example, sectors like Non-Banking Financial Companies (NBFCs), which are the largest borrowers from bond markets, may experience growth due to increased fund inflows. The banking sector will also get a piece of action because they’re required to hold at least 23% of their deposits as bonds. All of this will mean India’s bond market getting a glow-up! More investments could propel increased liquidity and action.
For investors and traders, staying informed and proactive is key.
Diversifying portfolios, understanding market dynamics, and being flexible with investment strategies are prudent steps in preparing for this economic transformation.
Right now, the yields on U.S. government bonds are rising, which make emerging market bonds less attractive. So, there might be bumps along the way and Indian bonds might not see as stellar response of fund flows from foreign investors.
However, India stepping onto the global bond stage is a game-changer.
It's an affirmation of our economic stability and potential.
As we move forward, a proactive approach in understanding and adapting to these changes will empower investors and traders to make the most of this significant milestone in our financial history.
Speaking of bonds, check out this short video to know how you can invest in gold through bonds: How to Invest in Sovereign Gold Bonds?
Until next time…
Sources: Kotak Securities, Money Control, Business Today
Disclaimer: This article is for informational purposes only and does not constitute financial advice. Investors should conduct their own research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.
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