Morgan Stanley (MS) has projected that inclusion of India in global bond indices will attract $170-250 billion in bond inflows in the next decade in its base/bull scenario.

The global financial services firm expects India to be included in global bond indices in early 2022. “Foreign ownership of Indian government bonds (IGBs) has been declining but 2022 would be the turning point that could bring an acceleration of bond inflows.” “The GBI-EM (Global Bond Index - Emerging Markets) and Global Aggregate indices are likely to include India in early 2022,” MS said in a report.

MS expects one-off index inflows of $40 billion in 2022/23, followed by annual inflows of $18.5 billion in the next decade, pushing foreign ownership up to 9 per cent by 2031. “This would have profound implications for the economy, foreign exchange, bond yields and equity markets,” the report said.

MS noted that India is keen to be included in global bond indices. Further, there has been a shift in attitude in the context that India has shown a significant improvement in macro stability and the government wants to push for capital expenditure (capex)-driven growth. “The opening up indicates policy-makers’ desire to push growth rates higher through investment. It will push India’s balance of payments into a structural surplus zone, indirectly create an environment for a lower cost of capital and ultimately be positive for growth,” as per the report, which has been penned by 10 MS officials, including strategists, equity analysts and economists.

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The firm believes that foreign inflows could flatten the IGBs (yield) curve by 50 basis points (bps). One basis point is equal to one-hundredth of a percentage point.

Further, a structural surplus in the balance of payments and improving productivity could drive INR (Indian Rupee) to appreciate by 2 per cent/year in Real Effective Exchange Rate (REER) terms.

Lower borrowing cost

The report recommended long 10-year IGBs, targeting 5.85 per cent. The benchmark 10-year IGB (coupon rate: 6.10 per cent) is currently trading at around 6.17-6.18 per cent. “Foreign inflows should lead to a lower borrowing cost, which helps debt sustainability, as it is important for India to keep an investment grade rating.

“Local market inclusion could reduce the likelihood of euro bonds. We expect 30-40bp of spread tightening,” the report’s contributors said.

The authors see banks benefiting from stronger growth and lower borrowing costs; private banks, particularly large ones, should be key beneficiaries. Among non-bank financials, potential beneficiaries are likely to be HDFC Ltd., Bajaj Finance, SBI Cards, Mahindra Finance and Cholamandalam Finance, the report said.

Corporate credit

The contributors opined that given the current historically low FPI utilisation rate, the India onshore corporate bond market had become a forgotten attractive opportunity for foreign investors. Hence, they expect foreign inflows to pick up in the medium-to-long term, thanks to better liquidity and higher yields.

The opening up of the sovereign bond market and resultant inflows should bring good news for Indian equity returns, thanks to a positive impact on growth and likely implications for softening interest rates, MS said

The authors believe this accentuates the case for India's return correlations to decline.