Positioning for India’s expanded role in the EM debt market

Tired of waiting – investor demand propels Indian debt to the mainstream

After a decade-long wait, Indian government bonds will soon begin a phased inclusion into the main index that is tracked by investors in emerging market (EM) local currency debt – the JP Morgan Government Bond Index – Emerging Markets Global Diversified (JPM GBI-EM GD). Entering the index with a 1% weight at the end of June and then rising by the same amount each month, Indian debt should reach its maximum-permitted 10% index weight by next April. To allow this, other markets will see their benchmark weights fall, with Thailand, South Africa and Poland set to be impacted the most.

Country weights in JP Morgan Government Bond Index – Emerging Markets Global Diversified, %

Source: JP Morgan, as at April 2024. Uruguay and Dominican Republic bonds are denominated in local currency but settled in US dollars. For more information on indices, please see Important information section.

Some US$330 billion¹ of Indian debt is eligible for index inclusion – this is the second largest bond market in the EM universe. Despite its size and high levels of liquidity, Indian local debt’s unique characteristics make it relatively difficult for foreign investors to access, which is why index inclusion has proven elusive until now. Hurdles to index entry include the lengthy process of opening local custody accounts, a requirement of pre-funding (which not all local custodians facilitate), and operational foibles around trading. While most of these challenges remain, significant investor demand appears to have tipped the balance in favour of index inclusion.

In just three years, the share of investors in support of India’s inclusion in the JP Morgan GBI-EM GD benchmark has risen from half to almost three-quarters². The increased appetite for the country’s debt is perhaps unsurprising – India has been grabbing a bigger share of the limelight thanks to strong macro trends as noted here and in our monthly EM Debt Indicator. That said, the shift is more likely related to exogenous factors due to index diversification concerns, namely:

• Russia was excluded from the index in 2022 following the country’s invasion of Ukraine.
• Turkey’s weight has dropped significantly over the last five years as a result of significant currency depreciation and rising bond yields.
• Egypt was removed from the index in January 2024 after being put on negative watch in September 2023 due to issues related to its foreign currency.
• The Philippines sole global peso note was removed from the index in January 2024 given poor liquidity, meaning the country exited the index at that point. The country’s local bonds (RPGBs) do not qualify for inclusion, mainly due to poor liquidity.

Impact of index inclusion on Indian bond valuations

While it is a significant event for the asset class, we do not expect index inclusion to have a material impact on India’s fixed income asset prices. Foreign ownership of Indian debt is low (currently c.2% and likely to remain below 5% once the inclusion period has completed); flows resulting from index inclusion will be relatively small in the context of the overall size of India’s debt market. In addition, although an estimated US$23.6 billion could flow into India’s debt market as a result of index inclusion³ - equating to around 17% of India’s annual net borrowing for 2024⁴ - we believe local financial institutions, including the central bank, are likely to soak up this demand. Inflows could provide a handy way for them to exit the sizeable positions they built up in the wake of COVID. All of this means the impact of stronger demand on the rupee and Indian rates is likely to be limited, in our view. Even if FX appreciation pressure were to materialise, we would expect India’s central bank to intervene in the currency market by accumulating US dollars and selling the rupee.

Active positioning considerations

Many of our benchmark-relative EM debt client accounts are already set up to invest in Indian local currency debt. Unsurprisingly, recent conversations have centred on how much exposure to include in portfolios and how quickly.

From a beta perspective, we think a gradual 1% increase in exposure at the index level is the best approach for several reasons. Firstly, it reduces the impact on other markets which will need to make space for India. Secondly, the approach is tried and tested, e.g., when China entered the benchmark in 2020. Thirdly, it allows investors time to iron out the operational intricacies of investing in the Indian bond market. Finally, and related to the third point, we believe there is a chance that investing in Indian debt may prove sufficiently cumbersome to prompt JP Morgan to insist on certain conditions being met before the maximum weighting is permitted. That could delay India reaching a 10% weight; an incremental approach to building exposure would be prudent.

From an active perspective, our current preference is for a benchmark-neutral stance on Indian duration as we believe valuations are quite rich and strong economic data suggests little need for the central bank to start easing policy rates anytime soon. However, we have a constructive view on the currency; outside of these expected inflows, India’s current account deficit is set to remain very modest leaving the overall balance of payments position in a healthy surplus. Coupled with high carry, this makes the currency attractive, in our view. 

A structural growth story

While we would welcome steps to improve market access and reduce the operational complexity and cost in investing in Indian debt, over the longer term, we believe India’s index inclusion is a positive for EM debt investors – not least given the sizeable structural growth opportunity it represents. India is home to 17% of the world's population, but it accounts for only 3% of the world's GDP, presenting huge growth opportunities. As our EM Equity colleagues noted here, India might well be following China’s exponential growth trajectory. The country’s corporate bonds (which represent 4% of JP Morgan’s CEMBI-Broad Diversified Index) are particularly interesting – especially in the transition investment space; India has shown a firm commitment to increase its share of renewable energy and there are already a number of strong Indian renewable energy companies that represent compelling investment opportunities, in our view. Look out for more thoughts on corporate credit opportunities in India in coming weeks.

¹ Source: JP Morgan, as at September 2023.
² JP Morgan, as at September 2023. 73% in 2023; 50% in 2021.
³ US$23.6 billion: estimated inflows into Indian debt at a 10% index weight (based on JPMorgan estimates of $236 billion AUM of dedicated investment tracking the GBI-EM Global Diversified Index. The actual figure is likely to be lower, especially given buying that’s already taken place ahead of index inclusion.
⁴ India Union Budget, February 2024. Net Borrowing is estimated to be US$141 billion, based on the current exchange rate of around 83.30 (converting INR11.752 trillion).