10 Oct 2023

James Cheo

Chief Investment Officer, Southeast Asia, India HSBC Global Private Banking and Wealth

While much of the world is grappling with an economic slowdown, India is shining as a bright spot with its solid economic growth outlook and stabilisation in inflation rates. In August, India's Consumer Price Index inflation rate retreated to 6.8% year-on-year, following a spike to 7.4% in July. We believe that the Reserve Bank of India (RBI) will end its monetary tightening cycle by holding the repo rate at 6.50% for the rest of the year. If inflation continues to move in the right direction, the RBI may even cut rates sometime next year. All these factors are supportive of Indian bonds.

Perhaps the most significant catalyst for Indian bonds is their inclusion in JP Morgan's Government Bond Index-Emerging Markets Global Index. This inclusion, beginning on 28 June 2024 until 31 March 2025, is expected to attract an estimated influx of USD20-25 billion from index-tracking fund managers. Active managers are also expected to join the fray, enticed by the higher yields and lower volatility of Indian bonds.

In addition to JP Morgan, other index providers such as Bloomberg and FTSE are also contemplating the inclusion of Indian bonds into their indices, which could potentially be multiple times larger than the JP Morgan’s inclusion. Active EM fund managers will try to position themselves ahead of the passive money before actual inclusion takes place.

This shift could mark a turning point in India's government bonds where historically, supply outpaced demand. With increased foreign inflows, the demand for Indian government bonds could finally outstrip supply, thereby driving bond yields lower (and raising the bond prices). 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 Indian rupee's exchange rate. In the near term, higher US rates and oil prices are key drivers for the rupee. We have recently seen a breakdown in the negative correlation between higher oil prices and the rupee. Despite the increase in oil prices, the currency has been fairly stable. With expected inflows for Indian bonds and the RBI likely to smooth the pace of depreciation of the rupee, significant downside for the currency is limited.

India's bond market is one of the largest in emerging markets. Global investors can gain exposure to India’s expanding opportunities by investing in its sizable and liquid domestic bond market, which now totals around USD2.3 trillion.

As global investors become more comfortable and familiar with the Indian bond market, they are likely to focus on more than government bonds but also corporate issuers.

Indian bonds can play a dual role in portfolios – as a diversification tool and for yield enhancement. Indian bonds have exhibited a low correlation with global bonds over the last decade due to the country’s unique growth dynamics, which set it apart from the rest of the world.

Currently, India's 10-year government bonds yield over 7%, offering a substantial 3-4% more than their counterparts in developed markets. Additionally, Indian bonds have higher yields compared to those in many other emerging markets.

Therefore, Indian bonds allow investors to access higher yields in a relatively uncorrelated and large emerging market and enhance diversification. To harness these benefits effectively, a well-diversified portfolio with Indian bonds, ranging from government and quasi-sovereign bonds to high-quality corporate bonds, is likely to be beneficial.

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