Investors already favored India's bond market. Emerging markets inclusion only sweetens appeal.

The inclusion of India’s government bonds into the J.P. Morgan emerging markets index in June will help increase flows, but global investors have already been overweight Indian sovereign bonds in recent months, if not years, investment managers said.

Local currency sovereign bonds from India will be added in 1 percentage-point increments each month to the J.P. Morgan Government Bond Index-Emerging Markets, the financial institution announced in September. By March 2025, India’s bonds will make up 10% of the index.

“For benchmark-aware strategies, managers will gradually scale their positions to remain sensitive to the prevailing benchmark constituents,” said Singapore-based Arvind Subramanian, senior analyst of manager research at Morningstar.

“That said, even prior to the inclusion, many strategies have held off-benchmark positions in India’s sovereign bonds, highlighting their positive view of the country,” he added.

Institutional investors have been interested in Indian bonds because of the country’s strengthening macroeconomic outlook, including robust growth, stable inflation and extensive foreign exchange reserves, he said.

In addition, India's performance within the widely tracked J.P. Morgan Asia Credit Index has stood out relative to peers in the region, he added.

“If you think about India, (with) yields as a whole at 7% for growth of 6.5%, compared to many parts of the world, it is very attractive for a country that is rated ‘outlook positive’ by S&P just (last) week,” said Singapore-based Howe Chung Wan, managing director and head of Asian fixed income at the $545 billion Principal Asset Management.

“There are many predictions around flows ... anything between $20 to $30 billion. But the main thing from an investor point of view is to know that this is a country on a structural, longer-term basis. It's very attractive for the yield, the credit rating, and that's why it is a story that's kind of exciting,” he said.

Credit rating

India’s credit rating also has a chance of being upgraded to BBB from BBB-, which makes it only one of two big countries — the other being Indonesia — that are “proper investment grade” and on an upward trajectory, Wan added.

The market index inclusion is a new phenomenon, but the Indian local currency bond market has been looked on favorably for a number of years, said Leonard Kwan, portfolio manager for T. Rowe Price’s dynamic emerging markets bond strategy, in response to questions at a media briefing in Singapore on June 11.

T. Rowe Price has $1.48 trillion in assets under management.

“The reasons for that is that it's actually a very big liquid domestic market with high yields of over 7%, and it's also got a volatility profile that is decorrelated from global rates. So from a portfolio perspective that actually offers good diversification with attractive yields,” said Kwan, who is based in Hong Kong.

India’s local currency bonds are also sensitive to domestic fundamental drivers, which are looking positive for bonds, he said. For instance, the inflation outlook is on the downtrend in India, which is supportive of bonds.

The index inclusion will lead to portfolio inflows, which paints a supportive picture, he said, but it will not be a material driver for the compression of yields. He added that the bonds are also well-anchored domestically by large pools of domestic buyers, which means it is less sensitive to international bond flows.

Further inflows are likely to continue, as Bloomberg Index Services announced in March that it would include India government bonds in its Emerging Market Local Currency Index starting January next year, said Nafez Zouk, emerging markets sovereign debt analyst at Aviva Investors in a written commentary. Aviva Investors managed £233 billion ($294 billion) as of March 31.

India is also expected to undergo rapid growth in the coming years, which will help reduce its debt burden of around 80% of gross domestic product, he added.

“The Indian government aims to reduce its deficit to around 4.5% of GDP in the coming years. While that is large relative to the pre-pandemic period, much of this increase is explained by increased government spending on infrastructure,” he said.

In addition, despite the country’s recent surprise election results, flows into local currency sovereign bonds are not expected to be derailed, investment managers said.

The general election, which closed on June 4, resulted in the re-appointment of Prime Minister Narendra Modi, but his Bharatiya Janata Party failed to win a parliamentary majority, leading to a coalition government for the first time in a decade.

The election result will not have a negative impact on India’s bond outlook, said Kenneth Akintewe, head of Asian sovereign debt based in Singapore at abrdn, in emailed comments. Abrdn manages and administers £495 billion ($630.2 billion) of assets on behalf of clients as of Dec. 31.

“The supply/demand dynamic for bonds (is) still very favorable and inflation and policy rates (are) still biased to come down. Indeed, the kneejerk response of higher yields and some currency weakness could indeed be an attractive opportunity to add risk,” he wrote.

Modi might face increased difficulties in implementing the more challenging reforms such as land, labor and certain agricultural reforms, but the BJP has proved itself resilient throughout the last decade, Akintewe said.

On the flip side, a coalition government might not mean a more challenging environment for markets to perform, said Rahul Ghosh, Singapore-based portfolio specialist for global equity at T. Rowe Price.

Historically, coalition governments in India were in power when India enjoyed some of the best stock market returns, he said. There is a fundamental level of optimism in the economy today and regulation can help support a positive market cycle, he said.