India’s Inclusion in JPMorgan GBI-EM Index

• 25 Sep 2023

For Prelims: India’s Inclusion in JPMorgan GBI-EM Index, Government Bond, Sovereign Bonds, Fiscal Deficits, Yield Curve, Reserve Bank of India.

For Mains: Significance of India’s Inclusion in JPMorgan GBI-EM Index and Challenges.

Source: IE

Why in News?

Recently, JPMorgan Chase & Co. will include India in its Government Bond Index-Emerging Markets (GBI-EM) index from June 2024, anticipating significant inflows to India. This move is expected to widen the investor base and potentially lead to the appreciation of the Rupee.

What is the JPMorgan Government Bond Index-Emerging Markets (GBI-EM) index?

• About:
  • The JP Morgan GBI-EM is a widely followed and influential benchmark index that tracks the performance of local-currency-denominated Sovereign Bonds issued by emerging market countries.
  • It is designed to provide investors with a representative measure of the fixed income market within emerging market economies.
  • It Includes government bonds issued by various emerging market countries.
  • The composition may change over time based on eligibility criteria.
• India’s Inclusion:
  • JPMorgan has identified 23 Indian government bonds with a combined nominal value of USD 330 billion as eligible for inclusion in the GBI-EM.
  • India's weight is expected to reach the maximum weight threshold of 10% in the GBI-EM Global Diversified, and approximately 8.7% in the GBI-EM Global index.
  • India's local bonds will become part of the GBI-EM index and its suite of indices, which serve as benchmarks for approximately USD 236 billion in global funds, as per JPMorgan.

What is the Significance of India’s Inclusion in GBI-EM Index?

• Enhanced Investment Attractiveness:
  • India's inclusion in the GBI-EM index positions India as a coveted investment destination.
  • It can attract global investors seeking opportunities in emerging markets, potentially resulting in substantial inflows of USD 45-50 billion over the next 12-15 months.
• Economic Stability and Financing Ease:
  • It can ease financing constraints related to India's Fiscal and current account deficits by providing an alternative source of funds.
  • It structurally lowers India's risk premia and funding costs, fostering economic stability.
    • Risk premia refers to the amount by which the return of a risky asset is expected to outperform the known return on a risk-free asset.
    • Equity market exposure is the best-known risk premium, rewarding investors for taking exposure to long-only equity investments.
• Positive Impact on Various Sectors:
  • Corporate Sector: The inclusion is expected to lower the entire Yield Curve, reducing the cost of financing for the corporate sector. Narrower corporate bond spreads will stimulate investment and business growth.
    • The Yield Curve is a graphical representation of the interest rates on debt for a range of maturities.
  • Banking Sector: With lesser pressure to absorb government bonds, banks can allocate more resources for lending to the private sector, promoting economic expansion.
  • Infrastructure Development: India's ongoing infrastructure development initiatives receive a boost as the inclusion provides a sustainable source of long-term financing through government securities.
• Currency Appreciation and Stability:
  • The inclusion will lead to an appreciation of the Indian rupee due to increased investor confidence.
  • A stable exchange rate enhances the attractiveness of investing in India.
• Market Development and Innovation:
  • Integration into global markets, supported by ongoing reforms and increased market access, propels market development and encourages long-term capital inflows.
  • It sets the stage for the introduction of innovative financial products.
• Par with other Countries:
  • India is expected to reach a maximum weightage of 10 % in the GBI-EM Global Diversified Index, putting it at par with others like China, Brazil, Indonesia and Malaysia.

What are the Challenges of India’s Inclusion in GBI-EM Index ?

• Market Fluctuations:
  • Inclusion may introduce volatility in local debt markets, especially during global economic turmoil or uncertainty, requiring the Reserve Bank of India (RBI) to manage and stabilize the markets effectively.
  • The RBI will need to carefully manage its monetary policy decisions to balance the impact of increased foreign investment while also ensuring domestic economic stability and growth.
• Geopolitical Risks:
  • High foreign holding of debt exposes Indian markets not only to external macro-economic shocks but also to geo-political risks. The recent experience of how Russia was ousted from international currency markets and the SWIFT (Society for Worldwide Interbank Financial Telecommunications) is a cautionary tale of how geopolitics can impact financial flows and hence economic well-being.
• Currency Management:
  • The inclusion may impact the domestic currency's value, posing challenges in managing exchange rates and ensuring the rupee remains competitive to support exports.
• Transparency and Fiscal Responsibility:
  • It may subject India to increased scrutiny regarding government finances, necessitating greater transparency and fiscal responsibility in managing the fiscal deficit.
• Taxation Challenges:
  • Unresolved tax treatment for foreign investors may deter potential investors, necessitating clarity and favorable tax policies to attract foreign capital into Indian government bonds.
  • The behavior of foreign investors, especially during global economic shifts, could result in sudden surges or withdrawals of funds, impacting market stability and capital flows.

Way Forward

• There is a need to work on resolving operational challenges related to custody, settlement, and tax implications to facilitate smooth participation of foreign investors.
• Strengthen the regulatory environment to ensure market integrity, transparency, and investor protection, encouraging long-term participation.
• Strengthen India's economic fundamentals to better withstand global economic shifts and fluctuations, minimizing risks associated with external factors.