Global economic shifts: A tactical opportunity for India to gain sovereign exposure

This article is authored by Kaustubh Gupta, Co-Head of Fixed Income at Aditya Birla Sun Life AMC Limited (ABSLAMC).

Understanding the Macro

The growth momentum in the U.S. has started to show signs of slowing down after a period of strong growth for most of the current calendar year. There has been back-to-back lower inflation print that has further strengthened the soft-landing view. The US labour market, while still strong in absolute terms, is now showing signs of slack.

The Euro area economy has been weak, led by the manufacturing sector. Chinese growth data has remained weak, and the property sector continues to struggle with home sales and prices both on a downward spiral. Global central banks, after aggressively raising policy rates in the last 1.5 years, have become data-dependent and are very close to the end of the rate hike cycle.

The growth story of India remains intact with 2QFY24 GDP coming at a healthy 7.6 per cent, broadly in line. Headline Inflation has moved within the target band of 4 per cent. Core inflation has been in line with expectations at 4.3 per cent in November 2023 on a year-on-year basis (43-month low). CPI (ex-veggies) in November month came in at 5.5 per cent y-o-y which. I believe that we are at the terminal rate in India and the bar for another rate hike is very high. A key risk to the inflation outlook stems from higher commodity prices, particularly crude.

Index Inclusion

JP Morgan recently announced the inclusion of Indian Government Bonds into its GBI-EM family of indices from June 2024. Total funds tracking the indices is about USD 236 billion. India has been given the highest weight of 10 per cent in its GBI-EM GD Index where the inclusion will be in a staggered manner with a 1 per cent rise in weight every month, reaching the maximum weight of 10 per cent by March 2025. 

There is also a likelihood that other index providers, particularly Bloomberg (India inclusion is already a part of their announced agenda for the upcoming meeting in November – December) may also include India in its bond index which can elicit further capital inflows. Net flows into fully accessible route (FAR) securities post announcement of JP Morgan index inclusion has already surpassed Rs 14,000 crore as of November 13, 2023.

Impact of index inclusion:

• Estimates of foreign inflows in the Indian bond market due to the inclusion in the JPM suit of indices are in the range of USD 30-50 billion (nearly a quarter of FY24BE net borrowing for GOI). This is a significant amount of foreign capital which is positive for Indian bonds and should depress Indian yields.
• The share of foreign investors in Indian bond markets has been quite low and the index inclusion with the maximum 10 per cent weight will be difficult to ignore both for active and passive investors and besides the existing FIIs, this will likely bring in a new set of FII investors into the Indian bond market.
• The entry of a significant new player into the Indian bond market shall be positive for Indian bond markets not only in the immediate period of index inclusion but also going ahead. India with its large size of economy, stable polity, healthy growth prospects and impeccable credit record shall continue to elicit interest from foreign fixed-income investors. It will bring in new foreign savings to fund Indian growth and will lead to the deepening of Indian financial markets.
• Besides the direct impact on bond yields the index inclusion will also be positive for external account, forex reserve and INR.
• The inclusion in the JPM Index (which has the largest AUM tracking in EM indices) will also potentially be a catalyst for India’s inclusion in other major indices (part of the announced agenda in the upcoming Bloomberg Index meeting) which can result in further inflows upfront and/or down the line.

Conclusion

Global growth is moderating, and inflation is slowly coming down. Global central banks are close to the end of the rate hike cycle. Domestic growth is robust and core inflation is within the expected range. Against this backdrop, the inclusion of Indian Govt Bonds (FAR Securities) in the GBI-EM index presents a very good tactical opportunity. I foresee a favourable demand scenario for G-sec, especially FAR securities, in the next 18 months.

Source: ABSLAMC Internal Research, Bloomberg, Gavekal Research, JP Morgan, CEIC and RBI