Informist, Friday, Jun 28, 2024

By Aaryan Khanna and Pratiksha

NEW DELHI – India's inclusion in global bond indices has been over a decade in the making. The watershed day when JP Morgan actually added Asia's third-largest bond market to its Government Bond Index – Emerging Markets suite, however, turned out to be a surprisingly quiet one for domestic bond and currency markets.

Ultimately, foreign portfolio investors bought only 16.54 bln rupees of fully accessible route bonds today, according to Clearing Corp of India data. The 10-year benchmark bond yield ended marginally higher at 7.01%, with the purchases somewhat offsetting the impact of a poor weekly auction. The rupee ended 0.1% stronger against the greenback, at 83.38 rupees per dollar, helped by the inflows for the bond market.

To most of the market, this wasn't that much of a shock. After all, India's weightage on the JP Morgan's marquee emerging market bond index rose only to 1%, and will rise by 1% every month till March 2025. The anticipation over the inclusion had been matched by 900 bln rupees, or around $11 bln, of bond buys under the fully accessible route over the past nine months. These bonds, with some caveats on duration and face value, are being included in indices operated by JP Morgan and Bloomberg in the next few months, and have no cap for foreign investment.

But some investors had expected $1 bln or more in index-related inflows today, and they were caught on the wrong foot in the foreign exchange market, dealers said. Bond dealers had anticipated up to 50 bln rupees of purchases from foreign portfolio investors just before trade started, with a large portion already front-run by foreign banks.

"Market-makers have been well positioned for index-related flows, and hence price action in IGBs (Indian government bonds) has been relatively muted," Siddharth Bachhawat, managing director and head of markets at Barclays, said. "FPIs have also been staggering their purchases, and accordingly activity has been spread out and not lumped up on a single day."

BLUSHING DEBUTANTE

Not only were the flows incremental, only a trickle made their way to the broader bond market. After all, foreign banks have amassed a warchest of bonds to eventually fulfil the needs of foreign investors: in June alone, they had net bought 469.54 bln rupees in the secondary market, before the inclusion. Today, they net sold 40.34 bln rupees worth of gilts in the secondary market, including the 10-year benchmark 7.10%, 2034 gilt that they picked up at the auction today.

For domestic banks, the only action they got was queries for off-the-run bonds under the fully accessible route. These were required by index-tracking funds to accurately match the allocation in the JP Morgan index, dealers said. FPI ownership has been minuscule as these bonds are not often traded, and foreign banks, too, have kept away from such securities so far.

While the Indian rupee rose against the dollar today, the scale of appreciation was nowhere close to what the market participants were expecting, all thanks to the RBI's active intervention. Today's central bank intervention sent out a clear signal to the currency market that the RBI will not allow any volatility in the exchange rate going ahead and will absorb inflows very actively.

In fact, market participants have kept their depreciation-bias for the Indian currency intact as it continues to hover near its record low level. The rupee hit a lifetime low of 83.67 a dollar on Jun 20.

"I don't see dynamics changing for the dollar/rupee (post bond index inclusion) that way. The only thing is that we continue to be mildly biased towards slight depreciation," Anshul Chandak, head of treasury at RBL Bank, said. "With so much active management happening to put the rupee in the range, it's very difficult to guess when a trigger happens."

Apart from the spot market, the reaction in the dollar/rupee forwards market was also muted, with the near-tenure forward premiums rising only marginally. Premium on the one-month dollar/rupee forward contract, which was expected to gain the most post the index inclusion, rose only 4 bps to end at 0.96%.

STILL A STARLET

Still, the muted introduction to the global market did not dispel the bright outlook for India's assets. The staggered nature of the inclusion by both JP Morgan and Bloomberg will ensure that neither bond prices nor the value of the rupee get jolted by sudden moves, dealers said.

"Going forward as well, do not expect any outsized moves each month when weightage increases by 1%," Barclays' Bachhawat said.

Even after the front-running, B. Prasanna of ICICI Bank expects another $20 bln worth of government bond purchases to come in from non-indexed foreign investors, either through India-dedicated funds or crossover allocations among other emerging markets. In an emailed comment, Standard Chartered also expects up $27 bln of additional inflows over the next 10 months.

"We still do not yet have the experience of stable, long-term indexed-allocations to our markets," B. Prasanna, group head - Global Markets, Trading and Research at ICICI Bank, said. "When the locals see real money, investors continue to stay invested in India for the long term, that’s when the confidence will come in that this is indeed real demand which can take some of the IGB supply off the hands of the locals."

Beyond that, it would be business as usual, as exemplified over the last nine months with slight and persistent bond purchases from foreigners, particularly as the index gets rebalanced every month based on the market values of the eligible Indian bonds. The pace of flows may accelerate once the rate-easing cycle kicks in globally, though that could still be a while away.

Currently, the CME FedWatch tool shows two-thirds of Fed fund futures traders see US rates easing by September, with another US rate cut priced in December. India's Monetary Policy Committee is widely expected to follow the US in cutting rates.

"Flows will incrementally go up, maybe in the next 30-40 days, not immediately. So, next three-five weeks, I don't think we will see any significant move," Chandak said.

US$1 = 83.38 rupees

IST, or Indian Standard Time, is five-and-a-half hours ahead of GMT

Edited by Maheswaran Parameswaran

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