Indian government bonds: completing the BRIC wall in local EMD

In the index portfolio management team, we have been managing local-currency emerging-market debt (EMD) for nearly 10 years, during which time we have seen tremendous growth in allocations to the asset class and supportive developments in the market infrastructure.

Yet the current universe of local-currency EMD is still much narrower than that of the main dollar-denominated emerging-market bond index. Indeed, there are currently four times fewer eligible issuers – just 20 countries – on the local side. We nevertheless fully expect to see this list expand; it has already evolved considerably, as shown below.

One significant market we consider as a highly likely potential new entrant to the index is India, as affirmed by index provider J.P. Morgan today.

The Indian bond market has experienced consistently strong growth over the past 10 years; we calculate the country’s five-year average annual growth rate to the end of 2020 as 26% for government debt issuance.

The market is opening, too. In March 2020, the Reserve Bank of India communicated that all 5-, 10- and 30-year issuance of government securities would qualify for India’s Fully Accessible Route (FAR) for foreign investors. FAR-eligible bonds make up 18% of total government debt in notional terms; to illustrate the appetite for this debt, the overall trading volume is split 60/40 in favour of Indian FAR-eligible debt.[1]

These two trends augur well for India’s inclusion in local-currency EMD indices. Holding all else constant, we calculate the inclusion of India into the main relevant index – the J.P. Morgan GBI-EM Global Diversified Bond Index – would equate to a circa 8.2% weighting allocation to the country.

This inclusion would give India a seat as one of the five largest weighted countries in the index, alongside China, Indonesia, Mexico and Thailand. The country weighting cap is 10%, which we expect India will reach fairly soon if included as it ramps up FAR-eligible debt issuance.

What about the impact on the index’s risk/return profile? India’s sovereign credit quality is BBB-, with a stable outlook, forming part of the investment-grade EMD world.

13 bonds, evenly distributed across the yield curve, are on J.P. Morgan’s 'index watch' list for inclusion. They have a total market value of $183 billion, and yield approximately 6% with a modified duration of around six years. We calculate a yield pickup of +13 basis points will be added to the index should India join, while the duration will remain materially unchanged at 5.2 years.

In addition to liquidity, we believe India can provide strong diversification versus other global emerging-market countries – we see it as one of the least correlated countries to the wider index universe, as shown in the matrix below.

From an environmental, social and governance (ESG) perspective, Indian government debt currently has a J.P. Morgan ESG score of 32.94. If included in an ESG version of the broader index, we estimate that the ESG tilting would reduce India’s allocation by circa 3.7% relative to the standard benchmark.

While India is the largest potential new entrant to the local-currency EMD index – and would be the final building block in the local EMD indices’ ‘BRIC’ wall – it is not the only country soon likely to be incorporated. In our next blog, we will examine four other candidates for inclusion, worth more than $250 billion in combined market value.

[1] Source: J.P. Morgan, CCIL, as at 30 June 2021