Bond branding

That FTSE Russell is considering including Indian government securities in the FTSE Emerging Government Bond Index provides a silver-lining to an otherwise bleak government bond market. The market is nervous about the deluge of government paper expected over the next 12 months. While the decision to place India on the watchlist for inclusion in the bond index does not mean that there will be an immediate flow of foreign funds into G-Secs, the eventual inclusion will certainly help create a sustainable pool of investors for Indian government securities. The RBI’s announcement that ₹7,24,000 crore will be borrowed in the next six months means G-Secs worth around ₹1,20,000 crore are going to be auctioned every month. With the FY21 fiscal deficit slated to be lower than the Revised Estimate, it was hoped that the Centre will need to borrow less in the new fiscal year. But the central bank is probably hoping to do much of the borrowing in the first half to ease the pressure on the market in the latter part of the fiscal.

The trends on bonds auctioned in the last two months suggest shows that excessive supply coupled with weak demand can push bond prices lower, increasing the interest burden on the Centre. The RBI’s Open Market Operations can help only to some extent; the only way out is to increase the demand for these securities. Now, banks hold a large chunk of G-Secs, at over 37 per cent, followed by insurance companies (25 per cent). Foreign portfolio investors held a piffling 2.1 per cent of outstanding G-Secs towards the end of 2020, down from 3.3 per cent a year back. FPIs have been net sellers in government securities since FY19, pulling out ₹141,000 crore over the last three years. FPIs are using up only 40 per cent of their G-Sec limit, fearing a dip in their value given the state of the fisc. Inclusion of G-Secs in the FTSE Russell Bond Index can encourage FPI investments , as the funds tracking this index will have to allocate money into Indian securities.

But the Centre needs to hasten to expedite the bond index inclusion. This is dependent on the country possessing a sound regulatory framework, a foreign exchange policy that is communicated clearly to the market, and availability of instruments for hedging both interest rate and currency risks. The tax authorities should avoid flip-flops and create a policy that incentivises FPIs to invest. Delivery and custody mechanisms must be sound. While India does score well on many of these parameters, it needs to further increase participation, liquidity and transparency in the bond market. The central bank also needs to prevent excessive volatility in the rupee since the returns of FPIs are influenced by currency movement.

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