How India Gains From Inclusion In JPMorgan EM Bond Index—Morgan Stanley's Take

India's joining JPMorgan's Emerging Market Global Bond Index will favourably impact the country's external balance sheet, deepen its bond markets, and lower the cost of capital, according to Morgan Stanley.

The inclusion begins in June 2024 with a weight of 1%, increasing 1% each month until it reaches 10% by April 2025. It is expected to lead to $30 billion in inflows into its government bond market, with monthly inflows of $3 billion during the inclusion period.

"This move has been supported by the government's introduction of the FAR programme in the February 2020 Budget (which removes foreign ownership limits) and a leg up in market reforms for aiding foreign portfolios," it said in a Sept. 24 note.

Only 30% of GBI-EM investors have actual India exposure in their portfolios, according to Morgan Stanley's proprietary database, it stated, despite the 73% of investors that supported the index inclusion, according to JPMorgan's survey, it said in another note dated Sept. 22.

Index Implication

Post-inclusion, India is set to become the second-largest emerging-market country in the index after China, bringing Asia's contribution to the index to approximately 50%.

Other countries' weights are to be reduced, with Thailand at 1.65%, South Africa at 1.36%, Poland at 1.27%, Brazil at 1%, the Czech Republic at 1%, Colombia at 0.78%, and Romania at 0.65%.

Macro-Economic Implications

Morgan Stanley expects that greater foreign participation in India's bond market would have a favourable impact on India's macro-economic indicators.

In the short term, it expects India's balance of payments surplus to rise, a reduction of external funding pressures on the currency, and an increase in liquidity.

"Over the medium term, the cost of capital is likely to come down, bringing about sustained and productive economic growth through a virtuous cycle of investment," it said.

Market Implications

The brokerage expects the 10-year benchmark goverment bond and rupee to outperform in the short term.

"We like long 10-year G-sec outrights without FX hedges, and we also add a bond to our 5-year NDOIS trade as we expect the asset swap to tighten."

It stated its recommendation to hold short TWD/INR and short CNH/INR during the short term.

"In the medium term, we expect investors to pre-position themselves before the index inclusion in June 2024."

Over the longer term, it states an expectation for the move to trigger other index inclusions, such as the Bloomberg Global Aggregate Index, which could attract another $10 billion.

Annual inflows into the G-sec market beyond the inclusion could be $18.5 billion, it said.

It also stated an expectation that the internationalisation of rupee and the reform of India's capital market could lead to special drawing rights inclusion for the rupee.

Key Risks

The few key risks that may upset market sentiment and disrupt foreign flows are:

• Volatility in global commodity prices, such as oil.

• Deterioration in domestic fundamentals, i.e., high inflation or a slowdown in growth

• Uncertainty in the political environment and a slowdown of reform momentum