India might be part of global bond index soon. But what is it?

India might be included in JP Morgan's 'GBI-EM' global bond index that tracks global debt bonds issued by governments of emerging countries. Here's what global bond indices are, how India's inclusion is a good money- making opportunity for investors, and how India stands to gain $30 billion in 10 years.

First, what is a bond market? If you are thinking of investing in mutual funds and you value the ''safety of your investments'' over volatile gains, your choice of preference will most probably be to invest in government bonds. This is because government bonds are super safe (unless we are talking about countries like El Salvador or Turkey). When your mutual fund invests in government bonds, mutual funds are basically giving your money to the government and in exchange receiving a fixed income for a period. The government uses this money for infrastructure, liquidity crisis and public projects. 

Just like the Indian government raises money by issuing rupee denominated government bonds, most countries issue government bonds in their own currencies to raise money from domestic investors. Investors also prefer these bonds because they are not as volatile as equity shares and governments have to pay interest and principal amounts to maintain their reputation and bring foreign investments. 

Next, what are domestic bond indices? Just like you have different kinds of equity indices (like Nifty Top 50) to track different kinds of equity stocks, Indian bond indices are a basket of many underlying Indian bonds. There are about 7-8 bond indices in India which generally track 3 different kinds of bonds:

• High yield risky bonds (bonds that are quite risky but also give high returns)
• Emerging market bonds (bonds that are issued by governments of emerging countries)
• Government bonds

So, what is a global bond index? Global bond indices are indices that track how different types of global bonds perform. Say you and I want to know which bonds are the best and want to check how US, UK, and Australian bonds are doing as compared to Indian bonds. But we are too busy to track so many debt markets. So we look at global bond indices to understand how global bonds are performing, and choose which debt to invest in. 

Who maintains these bond indices? Index providers are specialised financial institutions that employ financial executives to conceptualize, track and maintain bond indices from time to time. For eg:

1. To track the performance of government bonds, US-based JP Morgan has a ''JP Morgan Government Bond Index'' while UK-based FTSE has its own index called ''FTSE UK Gilts Index Series''. 
2. To track the performance of emerging markets, JP Morgan has a different index called ''JP Morgan Emerging Markets Bond Index'' and Citi has its own unique index called ''Citi Emerging Markets Broad Bond Index'' 
3. To track the performance of high-yield bonds, Bank of America has an index called ''(Bank of America) Merrill Lynch High-Yield Master II'' while Barclays has its own ''Barclays High-Yield Index''.

Why is India's inclusion in any Global Bond Index important? Inclusion will attract a lot of foreign money to India. For eg: As on August 2022, ''The GBI-EM index'' was made up of bonds from China, Indonesia, Thailand, Malaysia, Brazil, Mexico, and South Africa and the index's performance directly depended on how these underlying debt securities performed. 

If this bond index had done well in the last few months, global investors would have turned their attention and would have been interested in investing money in the bonds that make up the index. So the governments of these 7 countries have a higher chance of receiving foreign money. 

Now imagine if India was added to this list... 

So what kind of Indian bonds are being included? And in which index? JP Morgan's index called ''JPMorgan Government Bond Index-Emerging Markets (GBI-EM)'' is an index that tracks a basket of many debt securities issued in the local currency by emerging governments, in this case, Rupee denominated bonds by the Indian government. This particular GBI-EM index is the first comprehensive global Emerging Markets index. 

Why are Indian bonds being included NOW in the 'GBI-EM Index'? India recently overtook the UK to become the fifth largest economy in the world and is on track to be the third largest economy by 2030. In the equity market, India is the fifth biggest country, and India's $1 trillion sovereign bond market is one of the largest among emerging-market economies. Given that India has a different economic structure, including it in the index would be beneficial.  

But why weren't Indian bonds included in these bond indices till now?

Bonds are included in indices only when they fulfill certain criteria and are favourable to foreign investors in aspects like:

• Liquidity 
• Safety 
• Returns on investment 
• Size of the market 
• Sovereign bond rating
• Ease of access to the bonds  
• Settlement of investments proceeds (when sold) through specific international clearing houses like Euroclear 
• Taxability of gains

The Indian Sovereign bonds tick all criteria like liquidity, safety and returns. But the problem comes in when you consider settlement and taxability:

1. The 'settlement' process for foreign investors is cumbersome and the fear is that foreign investors may stop investing. 
2. The Modi government is unwilling to exempt foreign investors from capital gain tax as doing so would be discriminatory against domestic investors. 

So why will they include India if the tax criteria are not met? If a government bond satisfies other criteria very well or has strong investor influence towards the inclusion of the bond in the index, the index provider can make such changes. JP Morgan is conducting surveys among investors on whether they should include India in its GBI-EM Index and as per a Morgan Stanley survey, almost 60% of investors are ready for Indian bonds to be included.  

What does India's inclusion have to do with Russia's exit?

When Russia invaded Ukraine and the European and American governments imposed numerous sanctions, many index providers like MSCI, S&P Dow Jones Indices and FTSE Russell removed Russian bonds from their own respective indices. JP Morgan Chase too excluded sovereign and corporate Russian debt from its indices. Russian and Belarusian debt were also removed from emerging market indices.This means that investors were unable to invest in the Russian debt market and in case anyone had invested their money in them, then their investments could not be liquidated. 

As indices are made up of multiple debt securities from different countries, Russia's exclusion seems to have left a spot empty in the GBI-EM index. Thus Morgan Stanley expects that Indian bonds will now replace these Russian bonds. Meanwhile, global bond index providers are asking Indian government officials: 

How will it help India? You might have heard of how FIIs have been withdrawing their funds from the Indian stock markets for the last few months. In August 2022, the trend reversed and foreign funds invested $538 million in Indian bonds as the news of Indian bonds being included in the global index made a buzz. The 10-year benchmark yield is currently at 7.24%. India's inclusion in the indices could help India immensely in terms of foreign flows: 

• Though the current inflow stands at $18 billion (Rs 143,703 crore), the inflow could increase to $30 billion (Rs 239,506 crore) in the next fiscal year. 
• India's debt will make up 10% of the index, which is the highest among any other emerging country. 
• The foreign ownership of Indian bonds would increase from 2% to 9% by 2031 and Morgan Stanley expects about $170 billion (Rs 13,57,147 crore) in bond inflows.
• As per Morgan Stanley, bond investors can invest before the actual inclusion of Indian bonds in the index which would increase prices for a few months. Once Indian bonds are included in the index by June or September 2023, the actual substantial cash inflows would begin.
• The inflows will lift Indian bond prices thus giving initial investors a lot of gains!