Radhakrishnan says that “from a slightly longer term perspective, the fundamentals will play out and that should lead to material flows coming into the Indian fixed income markets over a period of time.”
How big a milestone is the inclusion of Indian bonds in JP Morgan index for the Indian bond market and what are those metrics which they would have gone through and ticked the boxes at before taking such a decision?
In terms of milestones, I do agree it is a significant development given the fact that this has been an ongoing negotiation between index providers, their investors, as well as the government and the RBI over a period of time and we have actually seen a significant amount of opening up in terms of debt limits. Now we have these FAR securities which do not have any investment restrictions and accumulative outstanding amounts of more than $350 odd billion.
So, from the perspective of deepening the market and more importantly to enable a new set of investors to be there on the demand side, it is a very significant development and in terms of impact on flows, one needs to see. The index inclusion process is a staggered process that starts from the middle of next year and ends by March ‘25. So, we will see flows coming into the markets over a period of time and it is a significant development from the perspective of ensuring that there is a new source of demand for government bonds.
A lot of people have started giving their reactions. Citi, for example, is saying that they expect India bond yields on the back of this development to fall to 6.8%. Directionally, what is happening in the world right now? Are India macros susceptible to global fragilities?
Yes, very clearly, on a relative basis, it is more relevant from a fixed income, a macro perspective. When you look at India’s balance sheet, on the fiscal side, or on inflation and on the external side over last so many years, during the taper tantrum incident, India was considered one of the fragile few and we had double digit CPI inflation, combined deficit was close to 10% and we did have significant pressure on the external sector.
In the last so many years we have seen on a relative basis a significant improvement in India’s macro. We have seen inflation come back from double digits and it has been a near-term challenge. But on a relative basis, we have seen a significant deceleration in India’s inflation and again compared to most emerging as well as developed markets, the inflation outcome in India has been relatively better. Fiscal dynamics has continued to improve and that is probably a little bit understated and not really being appreciated given that the incremental buoyancy that we are seeing in taxes.
A lot more positive stories will evolve on the fiscal side over the coming years and finally on the external sector because foreign investors in India’s fixed income market would be very wary or very conscious about how the currency markets play out and India’s external sector balance sheet is very strong.
So, we have a current account deficit which is eminently sustainable by stable capital flows. We are looking at something like a 1.5% deficit on the current account on a more sustainable basis which is completely funded by capital flows without creating too much of volatility. So, we are still looking at a situation where the balance of payment over a period of time should stay positive.
Now, on a relative basis, India’s inflation differential with the external world has significantly tightened or narrowed and the outlook on the currency should be fairly sanguine or fairly robust over a period of time. Of course, in the near term, when the dollar is on a broader strengthening trajectory and there are ebbs and flows in capital flow, the way it pans out in India we will potentially see the currency coming under intermittent pressure.
But from a slightly longer term perspective, very clearly India’s macros are far better than what it was 10 years back and today on a relative basis even when you look at economic growth rate projections, even at 6.5% real GDP growth, India’s growth outcome is materially better than most of the other markets. So, there is a good macro story on a structural basis, but yes, in the very near term, we have challenges and the single biggest challenge that we still have is inflation staying above the RBI’s upper end or the tolerance band.
The policy objective is to bring CPI inflation closer to the midpoint which is 4% and we still have a lot of distance to cover there even though the RBI has tightened rates over the last year or so. So, the immediate challenge from an Indian fixed income perspective would be how inflation actually comes back closer to the RBI’s policy target and what incremental actions may be required by the central bank. So, that is the near-term challenge.
But from a slightly longer term perspective, the fundamentals will play out and that should lead to material flows coming into the Indian fixed income markets over a period of time. It may not translate into flows in the very near term, I am talking about slightly on a longer term basis.