The inclusion, announced last year, will lead to index-tracking funds purchasing Indian bonds to align their portfolios with the index, creating immediate demand.It also enhances the visibility of Indian bonds and their credibility, attracting investment from a wider range of foreign investors. It is estimated that $20-25 billion of foreign investment will flow into India in FY25, given that Indian bonds will have a 10% weightage in the index.
Index chasing funds are estimated to have pumped in up to $500 million into the bond markets on Friday. The capital flows led to the strengthening of the rupee, which gained from 83.45 to 83.38 against the dollar. Despite a rise in the value of the dollar and crude oil in international markets, the rupee gained against the dollar because of the fund inflows.
“Since Oct 2023, non-residents have poured almost $10bn into Indian govt bonds, and an additional $5 billion though dollar-settled, rupee-denominated supranational bonds. With $2.3-billion inflow in June alone, there’s strong confidence that by the end of March 2025, index trackers will have a 10% weight allocated to India,” Parul Mittal Sinha, who heads financial markets in India at Standard Chartered Bank.
India’s local debt stock of $1.3-trillion govt bonds is the second largest in emerging markets, with bonds included in the index exceeding $400 billion, second only to China. India has the largest govt bond market in the region because of a historically large fiscal deficit for which banks were used as captive investors. Now with foreign investors picking up a large chunk of the bonds, banks will have more funds to lend leading to better rates.
“India’s relatively high yields among other index constituents can potentially convince active managers to shift to an overweight stance for these papers, along with the dedicated passive names. As it stands, positive real yields, low rupee vols, a supportive macro backdrop, strong defences against market volatility (record high reserves stock) and ongoing fiscal consolidation are key factors that make IGBs (Indian govt bonds) attractive for investors. In the near-term, we don’t expect these inflows to stoke material swings in the rupee or liquidity, courtesy the central bank’s active presence to minimise volatility,” DBS Bank senior economist Radhika Rao said in a note.