JP Morgan May Include G-Secs In Global Bond Index As Early As Next Week: Morgan Stanley

Even though the government is yet to make up its mind on inclusion of G-Secs (Government Securities) in global bond indices, Wall Street brokerage Morgan Stanley expects indices major JP Morgan to make an announcement in this regard as early as next week.

On Monday finance minister Nirmala Sitharaman told an industry gathering that the 2020 budget proposal on allowing bond inclusion in international indices could not move forward as the fund flows did not meet the desired levels, due to many reasons including the Covid pandemic.

Without offering any details like a timeline or the tax and stamp duty breaks that investors were demanding, Sitharaman said: "I don't know whether we're holding it back or not. I think global situation changed a lot since I made that statement in the 2020 budget. 

"Global fund flows have not been as big as we wanted it to be primarily due to other reasons. So it'll come to its natural, logical conclusion soon."

According to the RBI data, G-Secs outstanding stood at Rs 84.7 lakh crore, or over $1 trillion, as of end-June 2022 and the corporate bonds outstanding at Rs 40.4 lakh crore.

In a note on Tuesday, Morgan Stanley strategists Min Dai, Madan Reddy and Gek Teng Khoo said that "now we believe that there is a very good chance that JP Morgan will announce the index inclusion of India's bond market in mid-September."

They also said they expect the inclusion to drive in as much as $30 billion into the country next fiscal alone, even though there is no clarity on the tax breaks, which is a necessary condition for inclusion.

 Explaining how they arrived at $30 billon inflows, they said G-Secs Asset Under Management (AUM) that is tracking the GBI-EM is about $300 billion. Hence, 10 per cent weight for India in the index will attract $30 billion of inflows versus current foreign ownership of $17.8 billion. The monthly inflows of $3 billion would start in Q4FY23, spanning over 10 months until Q2FY24, they said.

Currently, there are 20 bonds in the FAR (Fully Accessible Route) list with total outstanding of $263 billion, and they are eligible for actual inclusion.

The report assumes that monthly increase of the FAR list bonds is $10 billion in the next 12 months, which means that eligible bonds will be about $360 billion in second half (H2) of 2023, making it the second-biggest bond market after China in the index.

As a result, India would join the 10 per cent club with China and Indonesia while the other 10 per cent countries -- Thailand, Malaysia, Brazil, Mexico and South Africa -- will see their weight dropping. The biggest fall will be for Thailand (-1.4 per cent), Poland (-1.4 per cent), South Africa (-1.3 per cent), the Czech Republic (-1 per cent) and Brazil (-0.8 per cent).

The government has to make some changes in capital gains tax norms to address the questions from Euroclear, which is a necessary condition for the index inclusion.

Additional forex inflows would help shore up current account and balance of payments, which are facing huge headwinds this fiscal due to crude price rise and increase in other imports. 

Consensus view is that the Q2 CAD (Current Account Deficit) will jump to 5 per cent from 3.6 per cent in Q1, which will be the highest CAD since Q3FY12 and close the FY23 at 3.5 per cent as they expect crude and commodity prices to soften from the second half of the fiscal.

The Morgan Stanley strategists see two key takeaways from the inclusion: the index team now has more incentive to include India on the back of Russia's exclusion; and most GBI-EM investors either support or don't object to the inclusion.

They also expect India to achieve 10 per cent in the GBI-EM index once inclusion is completed at the expense of Thailand, Poland, South Africa, the Czech Republic and Brazil.

Investors need a long lead time for the inclusion, hence we expect the actual inclusion to happen in Q3 of 2023. We believe that Euroclear is still achievable ahead of the actual inclusion.

Stating that 2022 budget disappointed a bit on the inclusion side, they said "after our visit to India in July and talking to officials, we felt that the government is still open and keen to have the index inclusion". They also admit that the inclusion per se doesn't trigger inflows but it can improve sentiment.

In the index review last October, India was put on the watch list as 60 per cent of investors supported the decision.

According to the report, JPM has already said that India needed to improve market access, trading and settlement to achieve index inclusion and said achieving Euroclear will improve market access significantly.

"While India made some progress in the past 10 months, we don't feel that this is material enough to change the overall assessment." But what happened in February/ March changed the dynamics, as Russia, with close to 8 per cent weight, was excluded from the index. The result is that now seven countries in the GBI-EM index have a 10 per cent weight: China, Indonesia, Thailand, Malaysia, Brazil, Mexico and South Africa, making the index quite unbalanced, they argued.

The GBI-EM index now has 20 countries. This means that the other 13 countries share the remaining 30 per cent, which never happened before as in the past, the top seven countries accounted for an average of 64 per cent of the index. Even back in 2016 when the top seven of the 15 countries accounted for 68 per cent.

Since exclusion of Russia has made the index more concentrated and unbalanced, JPM has more incentive to include India, even without Euroclear, as long as GBI-EM investors don't object to that, they said.

They said their in-house survey shows that 60 per cent of real money investors are either fully ready for index inclusion or almost ready, while their proprietary GBI-EM positioning tracker shows that investors have been actively managing India as an off-benchmark holding, although they have been cutting both duration and forex risks in the past few months.