India bonds inching closer to indexation

November 05, 2021 2:30 AM

Inclusion of India bonds in global indices is expected to materialise in 2022, with potential inflows of $30-40bn

Given that FAR Gsecs tick the criterion of market accessibility for inclusion in these indices, the inclusion of FAR Gsecs is possible in both indices, provided progress is made on concerns around settlement/operational hurdles.Given that FAR Gsecs tick the criterion of market accessibility for inclusion in these indices, the inclusion of FAR Gsecs is possible in both indices, provided progress is made on concerns around settlement/operational hurdles.

By Andre De Silva, Himanshu Malik & Hazel Lai

India government bonds have been on the radar for potential inclusion in popular bond indices for some time. One of the key question for investors is the potential size of inflows that the India bond market could expect on the back of index inclusion. We focus on two indices—Bloomberg Global Aggregate Index (BGAI) and JP GBI-EM Index (GBI-EM)—that are most relevant for potential inclusion of India and also in terms of having a meaningful flow impact, given a large number of tracking funds. Given that FAR Gsecs tick the criterion of market accessibility for inclusion in these indices, the inclusion of FAR Gsecs is possible in both indices, provided progress is made on concerns around settlement/operational hurdles.

The weight for India bonds in both of these bond indices should be determined on the basis of the outstanding amount of FAR bonds (over $200bn currently) rather than the total outstanding amount of Gsec issues ($1,040bn). When FAR was first introduced, there were only five benchmark securities, worth Rs 4.34trn ($7bn), but it was decided that any new issuance in 5-, 10- and 30-year maturity bucket will be included in FAR. Since then, the outstanding stock of FAR Gsecs has grown sharply, roughly at a pace of $20-25bn every quarter. Considering a similar pace of issuance and possible inclusion in early 2022, one could assume an outstanding stock of FAR Gsecs at close to $220-240bn. This is similar to the size of the Indonesia government bond market ($216bn) and make us believe that the potential weight for FAR Gsecs in GBI-EM could be slightly larger, at 8-10%, than our previous estimate of 6-8%. Indexation-related inflows on the back of GBI-EM inclusion could, therefore, total $24-30bn, assuming tracking AUM of around $300bn. Finally, weights in BGAI are based on the proportion of market capitalisation of its constituents and, as such, the weight for FAR Gsecs is expected to be closer to 0.3-0.5%, with potential indexation-related inflows of $6-10bn. In total, India’s inclusion in these two global/EM bond indices is expected to bring $30-40bn of foreign investments over 10-12 months, such that monthly foreign inflow could be around $2.5-3.5bn. Another point to note is that unlike GBI-EM, India’s weight in BGAI will likely continue to grow beyond 2022 with the outstanding stock of FAR Gsecs rising at a faster pace than other index constituents. Foreign investments in FAR Gsecs have already started rising since the introduction of FAR in March 2020, while foreign outflows have mostly occurred from non-FAR Gsecs. Since March 2020, non-resident holdings of FAR Gsecs have increased by $4.2bn, while foreign investors have reduced their holdings of non-FAR Gsecs by $6.2bn. In particular, it appears that inflows seem to have gathered steam in recent months in anticipation of positive announcements around index inclusion, but it also highlights that improving market access in itself is a factor for attracting foreign investments. With indexation-related inflows and crowding-in of non-resident investments from off-benchmark investors, we would expect the foreign ownership of FAR Gsecs to rise from a current 3% to 10-13% by the end of 2022.

Looking at the precedents within the region, it took 20 months for China to be fully included in BGAI due to its heavy weight of around 6%. However, given the expectation that only the outstanding Gsecs under FAR will be included into the index, India is estimated to account for only a 0.3-0.5% weight in BGAI, which is similar to the size of Indonesia when it was first included in 2018. That said, we expect India to be fully included into BGAI in a single run, following the footsteps of Indonesia. Despite the different timeframe for the inclusion of these two markets, the starting date of index inclusion usually comes 3-4 months after the confirmation, which we expect to be the same for India.

It is, in our view, that the confirmation may come by as early as the end of this quarter, if the aforementioned hurdles around custody/settlement are resolved, such that the bond inclusion will likely start to materialise in 1Q22. In the case of GBI-EM, we will expect the inclusion to take place over the course of 10-12 months in 2022, with a c1% increase in index weight per month, adopting the same approach as was done for China.

Edited excerpts from HSBC Global Research’s Fixed Income (Rates) report dated October 12

Respectively, head of Global EM Rates Research, Asia-Pacific rates strategist, & associate, HSBC

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