India could be included in the global bond index in early 2022, a move that may attract $170-250 billion in bond inflows for the country in the next decade, said Morgan Stanley in a recent note. Investors have been staying away from the Indian bond market in the past few years given the widening fiscal deficit, above-target inflation and gradually weakening currency. However, recent macroeconomic stability could change this in early 2022. India’s inclusion in the global bond index is likely to have profound implications for the economy, FX, bond yields, and equity markets, according to analysts at Morgan Stanley.
Desire for growth
India has shown a significant improvement in macro stability and the government has indicated its desire to push for capex-driven growth which is expected to result in an inclusion in the global bond index, making it the last emerging market to join the group. Although India historically, has had a mixed response toward foreign bond inflows, the same has changed in 2020. “The push for capex-driven growth alongside an improvement in macro stability has set the stage for a calibrated opening up of India’s government debt market,” Morgan Stanley analysts said.
The opening up of bond inflows, in Morgan Stanley’s view, hints at policy-makers’ desire to push growth rates higher through investment. “It will push India’s balance of payments into a structural surplus zone, indirectly create an environment for a lower cost of capital and ultimately be positive for growth,” they said. The consensus expects India to join global bond indices but the timing and implementation remain uncertain. With the floodgates opening for bond inflows, equity market returns could be higher due to the positive impact on growth and interest rates, the global brokerage firm said.
Stock markets to benefit: Financial stocks in focus
“Obviously, equity performance is a function of the growth and interest rate outlook. Equity markets do well when the growth outlook is strong and the rate forecast is benign,” Morgan Stanley analysts wrote. Indian banks are seen to be among the beneficiaries of the expected inflows. “We believe that the opening up of the sovereign bond market and resultant inflows will have multiple implications for the banking sector,” they said. Morgan Stanley analysts believe that over time the inflows will add to the source of growth capital and help to manage interest rates.
Large private banks are expected to benefit the most. Meanwhile, multiples are also expected to benefit. “Lower interest rates coupled with better confidence in growth/profitability is a great outcome for stock multiples. Overall, such a macro backdrop is good for equity prices, as it implies a lower cost of equity and stronger sustainable RoEs,” Morgan Stanley said.
Apart from banks, non-bank lenders are also seen as beneficiaries over the longer run. The opening up of the sovereign bond market and the resultant potential implications like lower longer-term G-Sec yields could result in favourable structural implications for NBFCs and HFCs — namely, higher foreign investor interest in corporate bonds, including NBFCs and HFCs, lower cost of borrowing and higher access to bond funding,” the report highlighted. Key frontline beneficiaries in Morgan Stanley’s view are likely to be Housing Development Finance Corporation, Bajaj Finance, SBI Cards, Mahindra Finance, and Cholamandalam Finance.