Why in News?

India officially became part of JP Morgan's Government Bond Index-Emerging Markets (GBI-EM). The inclusion is likely to bring nearly $20-25 billion into the country (over the next 10 months) and will help India manage its external finances and boost foreign exchange reserves and the rupee.

What’s in Today’s Article?

• Indian Bond Market - Challenges and Solutions
• What is the JP Morgan Emerging Market Index?
• What was JP Morgan’s Announcement?
• Impact of IGBs Inclusion
• Will Higher Inflows be a Concern for RBI?

Indian Bond Market - Challenges and Solutions:

• Importance of bond markets:
  • They are a boon for corporate bodies and government entities, providing a flexible and efficient way to raise capital.
  • One of the critical advantages for companies is the avoidance of equity dilution.
  • Moreover, the cost of capital is reduced as the interest expenses on debt instruments are tax-deductible, making it a more attractive option than other forms of financing.
• India's bond market:
  • India's bond market is pivotal in the country's economic structure.
  • As of September 2023, the government bond market size stands impressively at $1.3 trillion, with corporate bonds at $0.6 trillion.
• Challenges in Indian bond markets:
  • Narrow investment base,
  • Insufficient participation by foreign investors,
  • Virtually absent secondary market and
  • Private placement (a sale of stock shares or bonds to pre-selected investors and institutions rather than publicly on the open market).
• Panacea:
  • Inclusion in the Global Indices
  • Presence of market makers on both buy and sell-side
  • No credit default swaps
  • Bonds bhi ‘Sahi Hain’: A marketing campaign which can catch the eyeballs of all the age groups of the society.
  • Credit enhancement frameworks
  • Incentivising the issuer

What is the JP Morgan Emerging Market Index?

• Created in the early 1990s, it is the most widely referenced index for emerging market bonds and has become benchmarks for local market and corporate EM bonds.
• It began with the issuance of the first Brady bond - denominated in U.S. dollars and issued by developing countries and backed by the U.S. Treasury bonds.
• It has since expanded to include the GBI-EM (in 2005) and the Corporate Emerging Markets Bond Index (CEMBI).

What was JP Morgan’s Announcement?

• JP Morgan has announced that it would include Indian Government Bonds (IGBs) to its emerging markets bond index (starting June 28, 2024).
• There are 23 IGBs that meet the index eligibility criteria, with a combined notional value of approximately Rs 27 lakh crore or $330 billion.
• Only IGBs designated under the Fully Accessible Route (FAR was introduced by the RBI in 2020 to enable non-residents to invest in specified Government of India dated securities) are index-eligible.

Impact of IGBs Inclusion:

• India is expected to reach the maximum weight of 10% in the GBI-EM Global Diversified Index (GBI-EM GD).
• A higher weightage will prompt global investors to allocate more funds (~ $ 2-3 billion flows to India every month) for investment in Indian debt.
• It will not only result in lower risk premia, but will also help India to finance its fiscal and current account deficit (CAD).
• It will also help India to enhance the liquidity and ownership base of government securities (G-secs; debt instruments issued by the central government to meet its fiscal needs).
• The inclusion of certain Indian sovereign bonds will support a diversification of the investor base for Indian government securities.
• It could help lower funding costs slightly, and support further development of domestic capital markets.

Will Higher Inflows be a Concern for RBI?

• When the Reserve Bank of India (RBI) removes dollars from the market, it must release an equal amount in rupees.
• This means, while higher inflows will boost the rupee, the RBI will have to use the instruments in its armoury to check the resultant inflationary pressures.