Global investors are dumping Indian bonds. Blame it on the slow pace of reform
Even taken in isolation, the $14 billion outflow from the Indian bond market in 2020 is remarkable: foreign investors have never sold so much in a single year.
The fact that they did so at a time when Chinese bonds are attracting record foreign inflows underscores how frustrated some fund managers have become with the pace of capital market reforms by Narendra Modi’s government.
While China’s steady progress in bond market liberalization has earned it a spot in benchmarks and helped attract $119 billion in inflows this year, India still applies some of the toughest restrictions. Asian strict rules on foreign funds. The country’s failure so far to join China in global debt indices is adding to investor worries about low inflation-adjusted yields and widening fiscal deficit.
This could become a problem for Modi as his government borrows record sums to fight the pandemic. Although funding costs have remained subdued this year, the risk is that the growing supply of Indian bonds will start to outpace local demand. That could put upward pressure on interest rates and prevent Asia’s third-largest economy from recovering from its steepest contraction on record.
“India’s financing needs have increased significantly given deteriorating budget deficits and it is therefore essential that policymakers establish a clear framework towards a gradual opening of the market,” said Jean-Charles Sambor, Head of Finance. emerging markets fixed income securities in London. at BNP Paribas Asset Management, which oversees approximately $727 billion.
In response to questions from Bloomberg News, an Indian finance ministry official said the government is making progress on debt market reforms and plans to join global indices in mid-2021. “We are currently leading the process and necessary institutional changes to enable all participants to buy and sell Indian rupee bonds without difficulty,” said Sanjeev Sanyal, senior economic adviser at the Ministry of Finance.
Bloomberg LP, the parent company of Bloomberg News and Bloomberg Barclays Indices, said in September 2019 that it would help Indian authorities find a path to inclusion in international bond gauges.
Bond market liberalization skeptics have argued that India should tread carefully given the risk of speculative capital flows that could destabilize the currency. That concern is one of the reasons Modi’s administration quietly abandoned a plan, originally launched in 2019, to sell its first foreign sovereign bonds.
It is also debatable whether the short-term benefits of opening up to international bond investors outweigh the risks. India’s borrowing costs have fallen this year despite foreign capital outflows, partly thanks to bond purchases by the country’s central bank. Foreign inflows into the stock market, meanwhile, hit an eight-year high.
Yet as the government’s borrowing needs increase, it may find it harder to find enough domestic bond buyers. Modi’s administration plans to borrow a record 13.1 trillion rupees ($178 billion) in the fiscal year ending March and is expected to post a budget deficit equivalent to 8% of gross domestic product, the largest deficit in more than three decades. This comes at a time when Indian 10-year bond yields are hovering around 6%, almost a full percentage point below the rate of inflation.
India has taken some small steps to open up its bond market this year, including removing ownership restrictions on certain types of government debt. But these measures did little to stem the tide of outflows, with foreigners holding just 2% of outstanding Indian bonds at the end of November.
The reforms have also paled in comparison to those taken by China, whose debt is now included in – or on a gradual path to inclusion in – benchmark indices compiled by FTSE Russell, Bloomberg Barclays Indices and JPMorgan Chase & Co. JPMorgan kept India off its widely followed GBI-EM Global Diversified index in September, citing shortcomings in the country’s capital controls, settlement issues and outdated trading requirements, among other things.
This does not mean that international investors have completely abandoned India. Closer cooperation between local authorities and index providers, as well as a more stable exchange rate, could help pave the way for eventual inclusion in indices and more global portfolios, says Joevin Teo, Head of Fixed Income in Asia at Amundi Singapore Ltd.
Julio Callegari, senior portfolio manager for Asia rates and foreign exchange at JPMorgan Asset Management in Hong Kong, said he also hoped India would make progress on reform. But he warns it could take time.
“The truth is that India is still in its infancy,” Callegari said. “It should take a year or two to see the inclusion that would drive more bond investment into the country.”