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'Bond inclusion will lower cost of capital'

By Anjali Kumari
October 05, 2023 12:19 IST
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'The cost of financing the fiscal deficit will decrease, as new passive investors join in.'


Illustration: Dominic Xavier/

Vikas Goel, MD and CEO at PNB Gilts spoke to Anjali Kumari/Business Standard on the impact of JPMorgan's inclusion of Indian bonds in its global index, in a telephonic interview.


What will be the overall impact of bond inclusion in the near term and long term?

In the near term, which I define as two events -- beginning today, the announcement, and the actual flow which will start only in June --active traders will start taking interest in India, front-running the passive investors.

This is the beginning. There are two or three other indices that may also include India.

So, the market will remain big.

However, there are concerns that the actual flow will start in June, which has dampened Friday's euphoria.

In the long term, we'll see several positive outcomes.

First, the cost of financing the fiscal deficit will decrease, as new passive investors join in.

This will also lower the overall cost of capital in the country, benefiting corporate bonds and capital formation.

Secondly, India will become more connected to global fixed income markets, potentially facilitating more efficient financing of infrastructure projects.

The discussion about bond inclusion has been ongoing for some time. Why do you think the decision was taken at this particular time?

The concerns in question revolved around two key issues -- withholding tax and the challenges faced by smaller market participants, who tracked an index.

But they lacked the necessary infrastructure for onshore operations.

These smaller players sought offshore clearing and settlement through Euroclear, leading to a dual focus on taxation and infrastructure.

The situation became more complex as it touched on the taxation of onshore bonds traded offshore and domestically-issued bonds denominated in rupees being traded offshore.

Intense debates ensued on these matters. In the context of BRICS, India was the only member absent from the index.

With Russia's exit, India became the only viable market globally offering yield.

Bond investors and passive funds were compelled to engage with India to deploy their assets.

During negotiations, there was a clear desire for a favourable outcome.

However, India was in a strong position due to its government's fiscal prudence.

In essence, India's inclusion in the index happened on India's terms, driven by its fiscal strength and the concessions made by the index providers, rather than India compromising its position.

Do you think this inclusion will impact the borrowing pattern of the government?

I don't believe it will have a significant impact on the borrowing pattern.

Most investments will be in the 5 to 10-year range, which aligns with the current government's borrowing structure.

The demand will focus on securities between 5 and 14 years, so we may see a slight increase in the issuance of those tenors.

However, the overall borrowing pattern will remain relatively consistent.

The yield curve has been flat for a while. When do you see the situation improving?

I believe the yield curve's flatness can be attributed to the elevated levels at the short end.

This elevation is a result of the Reserve Bank of India (RBI) maintaining an overall tight monetary policy stance while gradually withdrawing accommodation.

Currently, liquidity conditions are exceptionally tight, as reflected in the NSE MIBOR fixings, which are even higher than the Marginal Standing Facility (MSF) rate of 6.75 per cent.

Consequently, the shorter end of the yield curve, spanning 1-2 years and 3 years, remains elevated.

However, I anticipate that as liquidity is normalised, it will serve as a precursor to the RBI initiating rate cuts.

In my view, the era of interest rate hikes has concluded, and now the focus is on when the rate cuts will commence.

The reinstatement of accommodation will likely occur in two phases.

Firstly, liquidity will shift from being negative to positive in the system, paving the way for the RBI to consider rate cuts, possibly within the next 9 to 12 months.

If, in the next 2-4 months, inflation begins to trend down as anticipated, the RBI may begin using liquidity as a tool.

This, in turn, will bring down short-term rates, ultimately diminishing the flatness of the yield curve.

Do you have any estimates of the amount of inflows expected after the inclusion?

As of now, the estimate is around $21 billion, but this amount could vary.

It will be approximately 10 per cent of the assets under management (AUM).

Depending on the AUM size at that time, it could be more or less than $21 billion.

Additionally, if inclusion happens in more indices, the total inflow could reach as much as $50 billion.

Feature Presentation: Aslam Hunani/

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Anjali Kumari
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