Potential Impact of Inclusion of Government of India Bonds on the JPMorgan Government Bond Index

(1) Introduction

In September 2023, JPMorgan announced that it would include India's local bonds in the Government Bond Index-Emerging Markets (GBI-EM) index, setting the stage for billions of dollars of inflows into the world's fifth-largest economy.

This move encompasses 23 Indian Government Bonds with a combined value of $330 billion. The inclusion will happen over a period of 10 months, with a 1% increase in weightage each month. By March 2025, India's weight is expected to reach 10%.

According to analysts, India's inclusion could lead to inflows of $20-25 billion into the country over a year.

(2)?Potential Impact of the Inclusion

India’s inclusion in the GBI-EM is expected to have several significant impacts on the Indian economy, currency exchange rates, and financial markets. We discuss a few:

(a)?Investments: The inclusion of India in the index is likely to attract substantial foreign investments into the country's government bonds. This influx of capital will increase the overall investment in the Indian economy. This will lead to higher capital formation, improved infrastructure development, and increased funding for various sectors, contributing to economic growth.

(b)?Liquidity: With the increased participation of foreign investors in India's government bond market, liquidity will improve. The higher liquidity will lower transaction costs and improve the efficiency of financial markets. Additionally, increased liquidity will attract more investors, further deepening the bond market.

(c)?Inflation: The impact on inflation is likely to be muted in the short term. While increased foreign investment can stimulate economic activity and potentially contribute to higher inflation, the magnitude of the inflows relative to the size of the Indian economy may not be substantial enough to have a significant immediate impact on inflation. However, over the longer term, increased investment and liquidity can contribute to inflationary pressures if not met with corresponding increases in productive capacity.

(d) INR Exchange Rate: The impact on the Indian Rupee (INR) exchange rate will depend on various factors, including the magnitude of foreign inflows, market sentiment, and RBI’s intervention policies. Initially, the increased demand for Indian government bonds from foreign investors may put upward pressure on the INR, leading to appreciation. However, sustained inflows could also lead to concerns about currency appreciation hurting export competitiveness, prompting the RBI to intervene to stabilize the exchange rate. Overall, the impact on the INR exchange rate is likely to be dynamic and subject to market conditions.

(e) FIIs and Equity Markets: The inclusion of India in the index is expected to attract FIIs to Indian financial markets, not only in government bonds but also in equities. FIIs may view India more favourably as an investment destination due to its inclusion in a widely followed global index. Consequently, equity markets will see increased foreign inflows, leading to higher stock prices. FII returns in the short-term will increase due to appreciation of the rupee, leading to further rush towards Indian equities.

(3) Conclusion

Overall, India's inclusion in the JPMorgan Government Bond Index-EM is expected to have positive effects on investments, liquidity, and equity markets. However, the exact magnitude of the impact will depend on various factors such as the results of the U.S. and Indian elections, conflict in Europe, global market conditions, and domestic economic performance.