The Global Bond Indices Conundrum
Updated: Oct 30, 2022
Image Graphics by Team Geostrata
It might be surprising for some people to learn that India's sovereign bonds, also known as G-Secs, are not listed on the global bond indices. While in September last year this seemed to be changing with certain government officials claiming that the idea was in its final stages of development, the hopes of foreign investors to see the G-Secs of the world’s 5th largest economy listed on global indices were dashed when FM Nirmala Sitharaman made no mention of a change in the tax regime during the announcement of the Union Budget earlier this year, which was necessary for allowing G-Secs to be traded on global indices.
To understand the significance of the possibility that the G-Secs might be listed on global indices, consider the recent increase in valuation of the Indian rupee, which has outperformed most of its emerging market competitors and even some developed market rivals against the US dollar, simply over the expectation that the G-Secs might get listed on global indices.
Currently, India's G-Secs are not listed on global indices like the Emerging Market Bond Index (EMBI) and global securities settlement platforms like Euroclear because they do not comply with their regulatory requirements, such as tax exemption on capital gains. Under Indian taxation law, capital gain is taxable, and to get G-Secs listed on global trade settlement platforms, the Indian government will need to bring a change to its current tax regime.
With JP Morgan & Chase Co. announcing the exclusion of Russian sovereign and corporate debt from its fixed-income benchmarks in the aftermath of Russia’s invasion of Ukraine, many investment banking firms including Morgan Stanley and Goldman Sachs Group Inc. were expecting Indian G-Secs to be listed on these indices. However, much to their disappointment, as of September 2022, there are no clear indications from the Indian government on its intent to list G-Secs on global indices.
To develop a well-rounded understanding of this conundrum, let us understand the standpoint of various stakeholders involved in this decision.
Foreign investors are eagerly awaiting India's inclusion in global indices and settlement platforms, which will allow them easier access to invest in one of the world's largest EM bond markets. At present, the settlement and trading of G-Secs take place in the domestic bond market only, making it inconvenient for many foreign investors to invest in India.
The government is set to borrow record high amounts due to the rising current account deficit which is expected to reach $105 billion this fiscal year on account of slowing exports as demand in European and US markets slows down due to the adoption of a tight monetary policy by their respective central banks. The inclusion of India in global indices will allow the nation to tap into global wealth and usher in funds to fulfil the country’s growing borrowing needs. According to an October 2021 report by Morgan Stanley, index inclusion of Indian G-Secs could lead to a bond inflow of $170-250 billion in the next decade. According to certain estimates, this could bring in $30 billion in inflows to India’s debt securities market.
The Indian government, however, seems to be proceeding with caution due to the possibility of volatile inflows in the domestic bond market which can affect domestic interest rates and hinder RBI's ability to control the yield curve, a function so crucial that in October 2020, RBI Governor Shaktikanta Das stressed on the importance of financial stability and proper evolution of the yield curve, stating them as public goods.
Further, G Padmanabhan, former Executive Director of RBI in a speech in 2015 warned that there might be a shift of the majority of transactions from the domestic bonds market to the global bonds market, with FPIs who are currently operating in the domestic market moving offshore and creating a parallel G-Secs yield curve outside India, a move that threatens to affect the Central Bank’s ability to maintain financial stability in the country.
Interestingly, another puzzling development was the Indian government’s stance during the Organisation for Economic Co-operation and Development (OECD) meeting in October 2021, where India voted in favour of a global minimum tax rate. It supported a country’s right to tax capital gain based on the location of the underlying asset, which contradicts the regulatory requirement of tax exemption on capital gains, which is necessary for allowing Indian G-Secs to be listed on the global settlement system. This further adds to the confusion about the stance of the Indian government concerning the global index inclusion of G-Secs.
Certain politically influential nationalist groups have also raised objections to the provision of tax exemption on capital gains to foreign investors, alleging discrimination against domestic investors. These groups have played a major role in influencing the government's decisions since 2014 because of their ability to influence the vote bank of the government.
At the moment, the government’s stance on this dilemma seems unclear with official sources claiming that the government will not factor in potential inflows from G-Secs listed on global indices indicating that the listing of G-Secs on global indices might be postponed to FY 2024. Yet, many including Madan Sabnavis, Chief Economist at Bank of Baroda, seem confident that the government will focus on its objective of enhancing the ease of doing business and investment in India and will list the G-Secs on global bond indices very soon.
The entire financial world is eagerly awaiting a clear decision from the Indian government on whether or not Indian sovereign debt would be listed on global bond indices. But it seems like the wait shall continue for a little longer, as the Indian government continues to comprehensively evaluate the possible ramifications of the move on the Indian economy to make an informed decision.
BY PRANAV ANAND