The Indian bond markets have been witnessing a significant level of transformation over the years. The Central Bank’s measures to improve liquidity and promote foreign investments in the Indian Bond markets have led to the deepening of the capital markets and in no small measure. But in order to understand these events, let’s take a step backwards and look at the origin and growth of Bond Markets in India.

The East India Company pioneered the concept of public debt, largely to finance its campaigns in South Africa. This eventually took the form of a more established means of creating sources of debt based on clearly set out terms and conditions. Thus came into existence – government banks, which we now know as the Central Bank. During the period between 1867 and 1916, public debt was largely used to finance railways, canals, etc. In 1894, the famous 3½% paper was created which continued to be in existence for almost 50 years. The Reserve Bank of India took over the management of public debt from the Controller of the Currency in 1935, when the total funded debt of the Central Government amounted to Rs.950 crores. Fast forward to the post-independence era when borrowings were influenced by the 5-year plans and by the recommendations of the Chakraborti Committee report. Post 1991, an active debt management policy was put into place and new instruments were introduced. The Fully Accessible Route (FAR) was introduced in 2020, thus making sovereign bonds accessible to a diverse group of investors. This move also paved the way for the inclusion of Indian sovereign bonds in global bond indices.

Here’s a timeline of the regulatory changes in the Indian Bond Markets:

Over the years, the central bank has been making significant moves towards the creation of a deeper, liquid bond market. RBI’s measures by way of announcing open market operations and making available corporate bonds at lower ticket sizes, with a view to have an active secondary bond market are strides in the right direction. These moves, fueled by the India’s growth make a compelling story for domestic as well as foreign investors to turn their attention towards the Indian debt markets.

In the year 20023, leading index provider JP Morgan announced the inclusion of India government bonds in their flagship GBI-EM GD Index. What does this mean for the Indian Bond Markets, and how does the inclusion impact the Indian Economy? And most importantly, what’s in it for me as an investor? We took a deep dive into the bond markets to get a better understanding.

The inclusion on Indian sovereign bonds will be phased-in starting in Q2, 2024, growing by 1% every month until it reaches the threshold at 10%. This means a gradual increase in the levels of inflows, making it easier to manage. On the face of it, this is great news. The inclusion of Indian sovereign bonds as part of the global index will give foreign investors the opportunity to invest in Indian sovereign bonds that offer a better yield as compared to some of the other markets. The exclusion of Russia from the index and a slowdown in China are likely to give an additional boost to India’s markets, especially considering the country’s growth trajectory. The JP Morgan index is due to carry 23 Indian Bonds with a notional value of $330bn, starting June 2024.

Here are a few advantages:

• Deepening of the bond market and enhanced liquidity and growth of the secondary bond market.
• An overall positive impact on the market sentiment, which will also provide an impetus in the equity markets.
• Increased exposure in the global markets; leading to a stronger currency.
• Potential for increased inflows into the country as the index weight increases.
• Potential for inclusion into other leading global indices, which will in turn increase the potential for inflows into the country.
• For the domestic investor, this could mean a more stable economy. The magnitude of inflows will likely impact the balance of payments in a positive manner.

And a few cons:

• Considering that we are likely to have significant foreign inflows over the long term, there is the likelihood of the market’s dependency on foreign flows also increasing.
• This could also mean a higher volatility that’s led by changes and or developments in the global markets.
• Despite the positive Balance on payments, India will have to keep buying US Dollars in order to absorb heavy flows, given its focus on ensuring the stability of the Indian currency.

Overall, we think that the inclusion of Indian sovereign bonds is a step towards the right direction. Although there are a few pro’s, we think that the inclusion of Indian sovereign bonds as part of the global index will mark a new era as we move towards creating a truly global economy.