India’s efforts to get its government bonds included in global benchmarks – eyeing potential investments from funds that track these indexes – intensified this month, but the need to address issues around market liquidity, electronic trading and hedging suggests the process will be glacial and the inflows thin.
In early February, India’s federal budget outlined plans to issue a special category of bonds that would have no ceiling on foreign ownership.
Although details were not available, Deutsche Bank analysts say to even get 10% of India’s net funding needs for FY21 (US$75 billion) from offshore index capital, the government needs to issue 30% of its gross borrowings via special bonds, and achieve inclusion into the GBI-EM index.
“The Indian government has been looking at ways of entering global indices for several years – it’s unclear if this will happen soon,” said Kenneth Orchard, Portfolio Manager and member of the global fixed income investment team at T. Rowe Price.
But analysts say there is a difference this time around.
“The difference this time is that the government has explicitly stated its intent to get included in global debt benchmarks. Being part of such benchmarks can structurally drive flows in the next 3-5 years. It all depends on which strategy the government adopts,” said Sameer Goel, Deutsche Bank’s Chief Asia Macro strategist.
That strategy is now keenly awaited with scant details available. New Delhi could look at the experience of China, the world’s second-biggest bond market, for some indications about the road ahead, analysts said.
“The lesson we learned from the China process is that it’s an onerous process. It’s not about just removing some foreign holdings caps,” said Karan Talwar, senior investment specialist EM debt at BNP Paribas Asset Management.
“There are measures like sufficient market liquidity, availability of electronic trading, easing operational hurdles, enhancing hedging tools to start with which India will have to make progress on and this will be followed by extensive consultation, investor feedback and other formalities prior to index inclusion.”
India’s bond market continues primarily to be a telephone-driven market, a feature which foreign regulators would like to see change.
“”If you are an investor based overseas you are subject to regulation that requires you to prove best execution for your end clients. The best way to do that is to harness data which is electronically captured by the electronic trading process on a trading platform. One clear benefit of trading in a competitive electronic environment is pricing efficiency relative to traditional methods. For India to get the benefit of a global community they may want to enable this quickly by leveraging the experience of a global trading platform which allows them access to existing investors while satisfying the investors regulatory obligations in each jurisdiction,” said Craig McLeod, Head of Emerging Market Product, MarketAxess.
Deutsche Bank analysts said in a note India could be considered for the JP Morgan Global Bond Index – Emerging Markets (GBI EM) – and the Bloomberg Barclays Global Aggregate Bond Index (BBG Agg), while the minimum credit rating requirement for entry of A-/A3 for the FTSE World Government Bond Index would mean the country is ineligible.
“The GBI EM has a market cap of 1.25 trillion global and tracked by 225 billion AUM while the BBG Agg 60 trillion and tracked by investors managing $2.5 trillion. GBI EM you get a larger weight more quickly and therefore fund flows will be faster. Inclusion in BBG Agg will mean a slower pace of infows but the flows will be for a longer period, and potentially a lot larger in total,” said Deutsche’s Goel.
JPMorgan and Bloomberg declined to comment. Barclays did not respond to a request for comment.
“They are reluctant to eliminate the caps on foreign bond ownership, which would be required for most index membership. One option being considered is special issues for foreigners that would be designed for index inclusion – these bonds have not been issued yet,” said Orchard, referring to the budget proposals.
India has an overall ceiling of 6% on foreign ownership of government securities with an individual securities cap of 30%, which stays in place even though it has an estimated room for a potential inflow of $20 billion.
The current channels for foreigners to access India’s bond markets are prone to volatile flows since investors tend to look at this asset class in an opportunistic and tactical manner.
But that could change once the new securities are issued.
“Currently the options that exist can make flows volatile because global funds will tend to take an off-benchmark and more opportunistic view which means unpredictable entry and exit,” said BNP’s Talwar.
“Once a country is included in a benchmark index, not only does it receive steady inflows from tracker funds but these tend to be sticky investments as passive investors are generally less sensitive to market conditions, they merely want to replicate index exposures.”
It is expected the country may follow one of three options – the introduction of new government securities, designating an existing benchmark bond as special securities or reopen older securities with significant outstanding stock and designate them as special securities.
India’s ministry of economic affairs did not respond to a request for comment and the Reserve Bank of India, the country’s debt manager, declined comment.
“The next sign to watch will be the borrowing program for next year due to be released in end-March. There they might signal details of the new proposed special securities,” said Deutsche’s Goel.