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Stars are aligned for India bonds

James Cheo
James Cheo • 4 min read
Stars are aligned for India bonds
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While much of the world grapples with economic slowdown, India shines as a bright spot. There has recently been a surge in India’s service exports — a pivotal driver for a shrinking current account deficit. This trend, in turn, bolsters the Indian rupee (INR). India also boasts a robust foreign exchange reserve, exceeding US$600 billion ($804.6 billion). This substantial reserve acts as a formidable anchor for the INR’s stability.

India’s economic growth outlook remains solid, accompanied by a stabilisation in inflation rates. Furthermore, both India and the rest of the world are poised for the end of monetary tightening cycles, adding to the appeal of India bonds.

India is undergoing an industrial renaissance, we expect the rise in India’s new economy sectors — high-tech services, digital start-up ecosystem, services exports — could raise its potential growth to 6.5% in the next 10 years, up from an average 6% growth before the pandemic. India’s strong government spending and private investment growth, robust FDI inflows and booming services exports will continue to power employment, private consumption, and productivity gains. We expect India’s GDP growth to reach 6.0% this year.

All eyes will be on the 2024 general elections in India, which will be held between April and May. The latest opinion polls and recent state elections suggest policy continuity. As the election season unfolds, government spending could potentially increase through subsidies. Once the election is over, and with more clarity on economic policies, there could be a re-acceleration of private sector capital spending. The path of fiscal consolidation will be closely watched and depends highly on the policy direction of the new government. 

India bond inclusion for global indexes a game changer
Perhaps the most significant catalyst for India bonds is their inclusion in JPMorgan’s Government Bond Index-Emerging Markets global index. This inclusion, which starts on June 28, will happen in 10 monthly increments of 1 percentage point each, attracting an estimated influx of US$20–25 billion from index-tracking fund managers. Active managers are also expected to join the fray, enticed by the higher yields and lower volatility of India bonds.

Beyond JPMorgan, other index providers are contemplating the inclusion of India bonds into their indices, which could potentially be multiple times larger than the JPMorgan inclusion. 
Active emerging markets (EM) fund managers will try to position themselves ahead of the passive money before actual inclusion takes place, which could drive up demand for India bonds.

See also: Lombard Odier sees three rate cuts for 2H2024, stays neutral on equities and overweight on fixed income

This shift could mark a turning point in India’s government bonds where historically, supply outpaced demand. With increased foreign inflows, the demand for India government bonds could finally outstrip supply, thereby driving bond yields lower. Consequently, this move is likely to reduce the government’s borrowing costs and elevate India’s credit rating.

These larger inflows will significantly ease India’s ability to finance its current account deficit while alleviating pressure on the INR’s exchange rate.

Encouragingly, there is a recent breakdown in the negative correlation between higher oil prices and the INR. Despite the recent run up in oil prices, the INR has been fairly stable. With the expected inflows for India bonds and the RBI likely to smooth the pace of INR depreciation, significant downside for currency is limited.

See also: Look out for rotation from growth into value areas for 2H2024: IG Asia strategist

Therefore, India bonds can provide a strong anchor for global investors in uncertain times. 

India’s bond market is one of the largest in the emerging market world with a market capitalisation. Global investors can gain exposure to India’s expanding opportunities by investing in its sizeable and liquid domestic bond market, which is now sized at US$2.3 trillion.

As global investors become more comfortable and familiar with the India bond market, they are likely to broaden out from government bonds and look toward corporate issuers.

Role of India bonds in portfolios
India bonds can play a dual role in portfolios — as a diversification tool and for enhanced yield. Currently, India’s 10-year government bonds yield over 7%, offering a substantial 3 to 4% more than their developed market counterparts. Additionally, India bonds have higher yield compared to many other emerging markets.

Moreover, India bonds exhibit a low correlation with global bonds over the last decade. This stems from India’s unique growth dynamics, setting it apart from the rest of the world. 
Importantly, the India bond market allows investors to access high yields in a relatively uncorrelated and large emerging market.

By incorporating India bonds into portfolios, investors can elevate overall yield and enhance diversification. To harness these benefits effectively, a well-diversified portfolio of India bonds, ranging from government and quasi-sovereign bonds to high-quality corporate bonds, is essential.

In conclusion, investors should consider India bonds as they present an attractive opportunity for both yield enhancement and diversification within a global bond portfolio. 

James Cheo is chief investment officer, Southeast Asia and India, at HSBC Global Private Banking and Wealth

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