India may attract $2 bn bond inflows around JPMorgan index inclusion day

Foreign inflows into Indian government bonds are set to hit a decade-high of $2 billion around June 28, when they will be included in a widely-tracked JPMorgan index. It is despite the fact that the Reserve Bank of India (RBI) is likely to lap up most of the dollars in its bid to avoid a knee-jerk rise in the rupee. Foreign flows following the inclusion could be in the range of $20-25 billion while forecasting a near-double increase in overseas holdings of local bonds over a year, as per JPMorgan’s claim. The $2 billion, single-day inflow estimate by experts trails only the record-high $2.7 billion poured into Indian bonds on August 20, 2014, as prospects of a credit rating upgrade gained traction. More than $200 billion in assets track the JPMorgan Emerging Market Index in which India will eventually have a weight of 10 per cent by next March, thereby suggesting total passive inflows of at least $20 billion over the 10-month period. The RBI, which has been keeping a hawk eye on the rupee as a measure to prevent it from plummeting to all-time lows, will be particularly vigilant as regards the inflows and speculative positioning on the currency.

Quite surprisingly, the central bank has not adopted additional surveillance measures. Since the rupee's real effective exchange rate -- a gauge of its relative value against a basket of currencies -- is signalling that it is moderately over-valued, the RBI is wary of any significant appreciation. True, this influx raises questions about the sustainability of these inflows, future yield movements and potential investor behaviour. So, while front-running in anticipation of the inflows may boost the rupee, a large rally is unlikely given the central bank's grip on the currency. The apex bank has clarified that it will continue to boost its forex reserves opportunistically, which, in turn, helps avoid a sudden spike in the rupee. Since there is no precedent for these debt index-related inflows, bankers' estimates of the timing of flows are based on similar index adjustments in the equity markets. In anticipation, large foreign banks could look at building short dollar/rupee positions to help manage inflows as and when they happen.

Still, despite the best-laid plans, concerns persist. First, this influx raises questions about the sustainability of these inflows, future yield movements and potential investor behaviour. If FPI inflows are weaker than expected, the yield dip will be less pronounced, potentially leading to market volatility and reassessment of investment strategies. Secondly, sustained inflows, according to many experts, will depend on th country’s economic fundamentals, such as GDP growth, inflation, and fiscal policies. Initial profit booking is likely, but overall inflows should remain robust. JP Morgan recently said that most of its clients were ready to trade in the IGB market. It estimates that inflows will be between $20 billion and $25 billion in a span of 10 months. Hence, it’s time to watch Indian G-Sec yield movements.