A WAVE OF passive capital flows are the prizes for countries securing a place in major bond indices. This prospect seems to be on the horizon for India. Many analysts expect part of its government bond market to enter indices compiled by Bloomberg, a data provider, and JPMorgan Chase, a bank, as early as next year, or perhaps in 2023. The government has held to inclusion even as it has been. ambivalent towards other types of capital flows. Its cautious approach is increasingly in line with the changing attitudes of economists.
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The flows that inclusion in major bond indices tends to generate are one of the least objectionable forms of international investment. They tend to come from massive, slow funds, unlike the volatile cash flows that emerging market policymakers fear. Perhaps this is why the inclusion of indices has been a priority for the Indian Ministry of Finance. Until last year, a 6% cap on foreign ownership of government bonds had been the main factor preventing India from being included in major bond indices. Next, the authorities introduced a “fully accessible lane” for foreign investors, which lifts the foreign ownership limit on certain bonds.
Analysis of the major investment banks suggests that a reweighting by global investors would result in flows of $ 30 billion to $ 40 billion in the Indian bond market. This would exceed the current stock of foreign investor holdings, which is only 2% of the more than $ 1 billion in Indian government securities in circulation. Reliable and regular inflows of foreign capital could help reduce public borrowing costs. Borrowing companies could also benefit from lower benchmarks. And the rupee would be strengthened, according to analysts at Morgan Stanley, a bank.
The hope of India, and many other governments in emerging markets, would be to emulate the experience of China. Foreign ownership of its central government bonds has more than doubled, from 4.5% to 10.6% in the past four years, without any notable setbacks and without compromising China’s broader capital controls. But the experience of other countries shows how unusually benign this is.
India’s recent relationship with portfolio investment flows explains the government’s reluctance to fully open up (ownership caps will remain on other bonds and assets). Significant outflows of foreign bond investors took place in 2013, 2016 and 2018, all motivated by expectations of a stricter policy on the part of the Federal Reserve. The 2013 massive sell-off in particular was accompanied by a sharp decline in the rupee. Foreign bondholders also rushed for the door at the start of the pandemic last year.
Even the IMF, once a staunch opponent of capital controls, is more equivocal these days. Last year, the Fund’s Independent Evaluation Office noted that the views of Indian authorities and the IMF on capital controls had become more aligned (although the fund was still more satisfied with allowing large exchange rate movements in response to external shocks than is the typical Indian policymaker).
The capital that comes with the inclusion of the index is also not entirely stable. Although inflows triggered by inclusion are much less sensitive to the national economic environment, they are between three and five times more sensitive to global financial conditions, suggests IMF research published last year. Investors often reduce their allocations to riskier emerging markets and fall back to safer assets like cash and US Treasuries during times of market stress. The fact that Indonesia was among the indices constructed by Bloomberg and JPMorgan, for example, did not stop foreigners from selling its government bonds in the spring 2020 panic. Foreign ownership of the country’s bonds had fallen to 21% in October this year, from 39% in December 2019. Research by the Asian Development Bank also shows that foreign ownership of local currency bonds can increase the volatility of capital flows, especially in markets the least developed.
However, international institutions do not recommend completely stopping the influx. In a report released earlier this year, the Bank for International Settlements, a club of central bankers, argued that deep and liquid financial markets, prudent monetary and fiscal policy, and strong corporate balance sheets could act as buffers. against the sometimes volatile ebb and flow of capital. . If India is to reap the full benefits of inclusion, it will need to heed this advice. â–
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This article appeared in the Finance & economics section of the print edition under the title “Overflows”