Foreign Portfolio Investors (FPIs) are showing strong positive reactions to the inclusion of Indian government bonds in the JP Morgan index. According to a recent report by the State Bank of India (SBI), FPIs have increased their aggregate holdings by Rs 16,990 crore since June 2024 and by Rs 95,687 crore since the announcement by JPMorgan Chase & Co. in October 2023.
The SBI report, released on Tuesday, anticipates that the index inclusion of Indian bonds could attract around USD 2 billion in investment over the next nine months. This surge in demand for government papers is expected to lower yields, particularly affecting short-end yields more significantly and rapidly.
The report highlights that 38 securities under the Fully Accessible Route (FAR) are currently eligible for inclusion in the JP Morgan Index. Despite the vast size of Rs 37 trillion, only 4.5% is currently utilized, leaving substantial headroom for further FPI investments, even after accounting for their current holdings.
The expected influx of foreign investment post-index inclusion is likely to deepen the government bond market and bolster system liquidity. The SBI report underscores that FPI inflows will support liquidity, exerting downward pressure on yields.
Moreover, these inflows are expected to supplement the Balance of Payments (BoP) surplus and increase forex reserves, though the rupee-dollar exchange rate is not anticipated to experience significant changes.
For the fiscal year 2025, the current account deficit is projected at USD 36 billion, approximately 0.9% of GDP, with exports of goods estimated at USD 455 billion and imports at USD 708 billion. Service exports are expected to grow to USD 171 billion. Net Foreign Direct Investment (FDI), which hit a low since 2007 in FY24, is predicted to recover to around USD 30 billion in FY25.
Foreign Institutional Investor (FII) inflows, currently at USD 3.5 billion this fiscal year, are forecasted to reach around USD 25 billion, driven by debt inflows from bond inclusion. So far, USD 2.3 billion has been invested, with another USD 18 billion anticipated.
The report also sheds light on the recent liquidity situation. From April 22 to June 27, 2024, the net liquidity was in deficit, except for a brief surplus from June 3 to June 6, mainly due to month-end government spending. Since June 28, 2024, liquidity has been in surplus mode, averaging Rs 0.94 lakh crore.
The SBI report notes that the current cash crunch, influenced by the Just-In-Time (JIT) mechanism, may ease with the anticipated increase in liquidity. However, this extra liquidity is expected to taper off over the years as RBI bonds mature, reducing the money supply.
The report cautions that global events causing capital outflows could destabilize the Indian financial system. The average supply of liquidity into Indian bonds via variable rate repo auctions in FY25 is Rs 1.3 lakh crore, while the average absorption through variable rate reverse repo auctions is Rs 0.27 lakh crore.
The Reserve Bank of India (RBI) plays a crucial role in actively managing liquidity through main and fine-tuning operations. The inclusion of Indian government bonds in JP Morgan’s Emerging Market Bond Index (GBI-EM) on June 28, 2024, is estimated to attract USD 20-25 billion in inflows. Since the announcement in September last year, India’s index-eligible bonds have already seen USD 10 billion in investments.
The inclusion of Indian government bonds in the JP Morgan index is expected to bring substantial foreign investment, enhancing market depth, and supporting system liquidity. While the increase in FPI inflows is a positive sign, careful management of liquidity and monitoring of global economic events will be crucial to maintaining financial stability.
