Bond Index Inclusion May Lead To Currency Appreciation, Lower Borrowing Cost, Says CEA
Citing various brokerages, Nageswaran said that this move could lead to an inflow of $20-$26 billion in a year.
The inclusion of Indian government bonds in the JPMorgan Emerging Markets Index could result in the strengthening of the Indian rupee on the back of inflows and the subsequent lowering of borrowing costs, according to Chief Economic Adviser V Anantha Nageswaran.
The inclusion is a "welcome development", reflecting confidence in the Indian economy, Nageswaran said while speaking to the media in a virtual briefing after the announcement on Friday.
Citing various brokerages, he said that this move could lead to an inflow of $20–$26 billion in a year.
This would also widen the investor base for Indian government bonds and perhaps relieve the Indian financial institutions from having to be one of the biggest subscribers to Indian government bonds—allowing them to park their funds with the private sector, commercial sector or individuals, he said.
"...the financing of the current account deficit also becomes that much easier because it is by-and-large believed that these investors are long term and patient investors and they are not fickle," he said.
Challenge To Ensure Rupee Remains Competitive
Given the potential of the rupee to strengthen when the index inclusion begins, it opens the door to both benefits and challenges in ensuring it stays competitive over time, according to Nageswaran.
“Naturally, there will be a tendency for the currency to appreciate, just as it happened between 2003 and 2008, and capital inflows into India surged. Therefore, when there is a demand for investors to buy the Indian government bonds denominated in rupees, then naturally the demand for rupees will increase, and everything else being equal, it will lead to a potential for the rupee‘s nominal appreciation,” he said.
In terms of borrowing, Nageswaran said that with everything else being equal, an incremental source of demand should see the Indian government’s borrowing cost come down, although he declined to quantify its magnitude at this stage.
Domestic Policy Needs To Be Sensitive To Global Perceptions
The inclusion also increases the sensitivity of domestic policy to external spillovers, requiring India to keep an eye on what foreign investors will be thinking, what will happen to bond yields, currency, etc., Nageswaran said.
We welcome these developments because the benefits of index inclusion appear to outweigh the concerns and challenges which other countries are also facing.V Anantha Nageswaran, Chief Economic Advisor
Indian bond market needs to prepare to face volatility during globally uncertain times, even if it's unrelated to Indian macro fundamentals, because of the inclusion or holding of Indian G-Secs by foreigners, he said.
"Fiscal and monetary policies need to be cognisant of the global perceptions," he said.
"...we also need to balance the portfolio or the foreign investor flows in the long term along with macroprudential considerations because ultimately, while foreign investors are looking to invest in India for its macroeconomic policy stability, the very act of their investment interest should also not jeopardise the macro stability. So, to that extent, macro prudential policies will also become critical down the road, if not now."