India’s breakthrough into global debt markets is in need of a second act.
Foreign investors have bought a net $20 billion of the nation’s index-eligible sovereign debt after JPMorgan Chase & Co. announced India’s inclusion to its benchmark emerging market index in 2023. Recent outflows have left total investments on the low end of estimates by analysts.
This year’s underperformance is stark given how emerging markets everywhere benefited from a ‘Sell America’ trade that spurred reallocations by investors. A Bloomberg index tracking the performance of EM local currency debt hit a record high in June, while other Asian nations from South Korea to Malaysia have seen renewed interest from funds.
What’s holding back India is a currency that has been left behind as almost every Asian peer strengthens against the dollar. The central bank’s recent pivot away from more immediate monetary easing also spurred outflows, and highlights the need to attract sticky, index-tracking funds. The $3.4 billion of bond sales from April reinforces the call for more reforms before the nation joins another global debt benchmark in September.
“Indian bonds primarily attracted active investors rather than passive, structural flows,” said Nitin Agarwal, head of trading at Australia and New Zealand Banking Group. “The theme for active investment in India was monetary policy, which has now played out, and the bond rally is perceived to have run its course.”
Also Read: Rupee Opens Flat Against US Dollar
The nation’s bonds officially entered JPMorgan’s index in June last year.
Indian sovereign bonds posted a return of 2% in dollar terms in the second quarter, against 5% by a gauge of emerging-market debt. A rally in benchmark 10-year bonds earlier this year — with yields dropping by about 50 basis points — has more or less stopped.
The monetary and currency policies of the Reserve Bank of India have become the key drivers for the nation’s debt this year. After the RBI slashed its benchmark interest rate by 50 basis points in June, it switched to a neutral policy stance, signaling limited room for further easing.
Meanwhile, the rupee’s absence from the emerging market rally also has dampened appetite for Indian bonds. The currency is little changed versus the dollar this year, lagging well behind the Taiwan dollar’s 13% surge and the South Korean won’s 8.6% gain.
“For foreign investors, total returns in local currency bonds are driven by both bond returns and FX returns,” said Nagaraj Kulkarni, co-head of Asia rates (ex-China) at Standard Chartered Plc in Singapore. “On the FX, the rupee has been an underperformer in the region even in the recent bout of USD weakness.”
The RBI’s decision to build up foreign reserves to fend off rising economic and geopolitical risks has weighed on the rupee, and the recent bond outflows have in turn further pressured the currency.
The outflows from April have prompted policymakers to act. The Securities & Exchange Board of India relaxed some rules in June for overseas investors, while the RBI allowed the operation of electronic trading platforms to facilitate more foreign participation.
More reforms will be needed, according to investors such as Kenneth Akintewe, head of Asia sovereign debt at Aberdeen Investments. Chief among the structural hurdles is the nation’s high tax burden. There’s a 20% interest income levy, while short-term capital gains on bonds can be as high as 30%.
“When you are managing a global portfolio, it is easier to ignore or bypass a market if there are too many impediments to accessing the market,” said Akintewe.
Still, there’s optimism among some investors that India’s debt markets will bring in more foreign funds. A domestically-driven economy makes it more resilient to Donald Trump’s tariffs, while the government has demonstrated strong fiscal discipline.
“What international investors like about India’s bond market is similar to the reasons that they like the Chinese bond market — because of its own individual policy making, more domestically-focused economic activities,” said Yifei Ding, fixed-income portfolio manager at Invesco Hong Kong Ltd.
“Given the size of the Indian economy and the size of the Indian fixed-income markets, it’s not difficult for India to see high single digits foreign ownership in its government bond space,” Ding said.
Global funds only take up 3% of the nation’s $1.3 trillion sovereign bond market, compared with 5.8% in China, as of the end of May, according to Bloomberg calculations of official data.
The next milestone will be in September, when FTSE Russell begins to include Indian debt into an emerging-market index. Meanwhile, Bloomberg Index Services Ltd. already started adding rupee notes in one of its gauges in January over a 10-month period.
Bloomberg LP is the parent company of Bloomberg Index Services, which administers indexes that compete with those from other service providers.
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