JPMorgan's Inclusion of Indian Bonds: A Boon for Debt Mutual Funds?

Synopsis

Investing in long-term government securities is advised for debt mutual fund investors, since the inclusion is anticipated to generate flows. This would cause prices to rise, which would result in yields falling.

Indian government bonds (IGBs) are now included in JPMorgan's index of emerging market government bonds, which is a prominent player in the global financial services industry, as of June 28. The addition forces investors throughout the world to take notice of the Indian fixed-income market, marking a significant turning point in the market's history.

IGBs will eventually reach the maximum permitted weight of 10% in the JPMorgan Government Bond Index-Emerging Markets (GBI-EM) during the course of the next ten months, after monthly weightage increments of one percentage point.

IMPACT ON INDIAN BONDS

It is anticipated that the inclusion will draw a sizable amount of international capital into the local market given that foreign investors are underallocating to Indian bonds. According to market estimates, the total amount of money coming in over the next six months from both active and passive investors could be between $20 and $40 billion.

Since international investors appear to be in a good position to take advantage of this right now, the short-term effects of include Indian bonds will be minimal. In the long run, nevertheless, when new capital enters the market, this represents a turning point for bonds. Over time, it is anticipated that inflows will continue to rise and that the credit curve for corporate bond investments would flatten.

The inclusion will increase demand for IGBs, which will raise bond prices and boost financial stability in India.

Furthermore, the amount of foreign currency, such as dollars, that is exchanged for rupees will increase as a result of international investors purchasing Indian bonds. The demand for the rupee will therefore probably rise, strengthening it relative to other currencies.

The Reserve Bank of India (RBI) will therefore need to intervene more forcefully to prevent the rupee from appreciating too much as a result of greater foreign flows, which are anticipated to cause some volatility in the currency markets. We anticipate that the RBI will absorb the majority of the dollar inflows and minimise the impact on Indian currency given their operational track record.

HOW COULD YIELDS BEHAVE?

With the index inclusion, international investors may continue to be positive on long bonds, and Indian bonds may witness a downward shift in the yield curve, which would ease bond yields across the curve, provided the RBI doesn't remove a significant portion of the additional system liquidity.

Conversely, short-term rates will have little to no effect if the RBI actively absorbs the liquidity generated by its FX interventions. A flatter yield curve will therefore result from buoyant demand at the longer end of the yield curve.

The addition will increase the system's liquidity and broaden participation in Indian bonds.

The 10-year benchmark is expected to trade between 6.75 and 7.05 percent after inclusion, down from its current level of 6.99 to 7 percent. Strong demand, lower interest rates, and reduced inflation will push the benchmark closer to a 6.50 percent yield.

TIME TO BUILD A DEBT PORTFOLIO

A lot of investors would view the index inclusion as a strategic way to profit from a spike in foreign inflows. Experts contend, however, that investors ought to view the Indian bond market far more through a strategic than a tactical lens.

As inclusion appears to be priced into the current market, there will likely be little immediate impact on debt fund investors.

Eventually, nevertheless, it will be advantageous to acquire a fresh batch of sizable fixed-income investments because returns will eventually decline. Investors should diversify their portfolio into bonds in order to preserve cash and take the bull market rally head-on. Purchasing government bonds to extend duration and purchasing high-yielding bonds for two to three years could be a good barbell approach.

Given that bond prices are expected to rise, investors should increase their exposure to and debt portfolio in long-term debt funds by combining government securities, or G-Secs, with bond funds.

Investors may see a substantial capital gain from this, and we anticipate future rate reductions from the central bank. A healthy inflow following inclusion will also support bond price movement.

STRATEGY FOR DEBT FUND INVESTORS

Increased foreign portfolio investment in G-Secs may result in capital appreciation for investors on their present debt funds.

A rise in demand will drive up prices, which will cut G-Sec yields and the debt funds that own them. Thus, lesser returns could be faced by investors in the future. G-Secs have become the benchmark for investors seeking secure investment opportunities. Retailers, on the other hand, are mostly yield-hungry and look for credit papers with greater yields. Most of these assets are not affected by changes in G-Sec rates.

Experts feel that long-term government bonds present a solid opportunity because there is a strong case for long-term yields to drop over the next one to two years.

Considering their ability to adjust if circumstances don't turn out as planned, dynamic bond funds are most likely in a good position to take advantage of this chance. To weather the sporadic volatility, investors must, however, have a lengthier holding time of at least two to three years.

Liquid funds are the best option for investors with short investment horizons and minimal risk tolerance.

Author : Prayas Sarkar, MBA Finance

Post Graduate Programme of Financial Markets