India not to be included in Global Bond Indices in 2022

It was nearly $40 billion at stake. That was the kind of money that was estimated to flow into India when the bond index funds were allowed to invest in India. The pre-condition for that was that Indian bonds had to be included in a major global bond index like the JPMorgan Bond Index or the FT Bond Index or the Bloomberg Bond Index. Among the various bond index service providers, it is JP Morgan whose indices are tracked the closest. But for now, after all the hype created earlier this year, Indian government bonds are out of the emerging-market sovereign bond index  due to a number of hurdles on the way.

What JP Morgan has done is that it has refrained from adding the Indian government bonds to the JPMorgan Government Bond Index-Emerging Markets. However, it has still kept these bonds  under review for inclusion. This was largely based on the investor feedback. The big takeaway for India was that if Indian bonds get included in these bond indices, then the passive flows of $40 billion or thereabouts would flow into India. That would not only make the bond markets more liquid but also give a boost to the Indian rupee. However, with the inclusion in the bond index put off, that is not happening for now.

There are several hurdles to this inclusion, which are yet to be resolved. For instance, most institutions are still unhappy with the lengthy investor registration process in India. Also, the operational readiness required for trading, settlement and custody of assets onshore is still not there since India is not yet a member of Euroclear; which is the global protocol for bond trading. In addition, the issue of capital gains withholding tax remains the biggest hurdle. Index fund managers are touchy about costs and wanted the withholding tax scrapped. However, the Indian government has refused that point blank. That was the big reason. 

There is one more reason why the government refused concession on capital gains tax. Of course, the first reason is the lack of parity with the domestic investors. The bigger reason is that the government wanted to be self-reliant in its funding. It was tad worried about $40 billion of debt capital flowing into India at a time when global markets were very uncertain and tentative. Waiver of capital gains tax would have resulted in a deluge of foreign debt flows and that could have added to the problems of volatility rather than resolving it. That was the bigger reason for the government to not agree on the capital gains tax.

On the downside, this announcement could partially weigh on bond market sentiments and also the value of the rupee. In the last few weeks, a lot of hot money had flowed into Indian debt on the hopes that India would be included. Now that is likely to unwind and that would put pressure. Due to these expectations, the bond yields had also stayed low but that could also see a spike as the index inclusion is not happening now. After all, India is the only $1 trillion market that is still not in the global bond indices. It looked like India may replace Russia after the Ukraine war, but not that is not happening in 2022 for sure.