India’s failure to have a presence in any major global bond index has been a thorny issue so far, and JPMorgan has received a warm welcome as it became the first index provider to include India in its emerging markets index. This effort is commendable as various hurdles, including capital controls, accessibility of G-Secs in India and tax-related issues, had to be overcome before index providers could be included. But this optimism needs to be tempered as forecasts of potential inflows are exaggerated.
This inclusion in global indexes is necessary because global passive funds, such as exchange-traded funds and index funds, have portfolio allocations consistent with the index to which they are tied. With India’s weighting in the J.P. Morgan Emerging Markets Bond Index set to increase to 10%, all passive funds tracking the index are also likely to invest in Indian government bonds over a 10-month period starting in July 2024, increasing demand for these bonds. This helps flatten sovereign yields, support government borrowing and rupee appreciation, and boost foreign exchange reserves.
But the commonly used figures ($20 billion to $50 billion) for potential inflows into Indian G-secs from July 2024 to March 2025 appear to be somewhat stretched. The figures come from a J.P. Morgan press release, which states, “GBI-EM GD (the index that primarily includes India) accounts for $213 billion of the estimated $236 billion against which the GBI-EM family of indexes are benchmarked.”
Analysts believe that the minimum amount that will flow into India over the next two years is 10% of the $213 billion, or $21.3 billion. This number is further widened on the assumption that passive funds linked to other JPMorgan indices as well as Bloomberg-Barclays and FTSE Russell indices will also enter India in the coming years.
The basic problem is that the forecast assumes that all funds linked to the J.P. Morgan index are passive funds. But that may not be the case.
Second, passive funds do not exactly follow index weightings, leading to inaccurate predictions.
Third, global bond funds have been allowed to invest in India, but they are not keen on buying Indian government bonds. This is because Indian G-Secs are relatively less attractive compared to other sovereign bonds.
Benchmarks don’t track
It should be noted that JPMorgan Chase stated that the emerging market index GBI-EM GD has US$213 billion as a benchmark. Both active and passive funds use the term “benchmark,” while passive funds use the term “tracking.”
Active funds give fund managers the freedom to invest in any security in a defined category. The Funds are not mandated to invest in all securities in the benchmark index.
For example, many Indian large-cap mutual funds are benchmarked against the Nifty50. But they are not mandated to invest in Nifty50 stocks or follow Nifty50 stock weightings in their portfolio allocation.
Therefore, an active fund benchmarked against the J.P. Morgan Emerging Markets Index may or may not invest in Indian government bonds.
Passive funds, on the other hand, track the index. In other words, the fund manager must invest in all securities in the index, primarily according to the index weight, although the allocation may differ slightly in some cases. Fund managers do not make any active investment decisions, hence the name “passive funds.”
The $213 billion fund linked to the J.P. Morgan Emerging Markets Bond Index can be active or passive. Since active funds linked to the index do not have to allocate 10% of their portfolios to Indian G-Secs, minimum inflows are likely to be lower than forecasts of over $20 billion.
Numbers don’t add up
In addition, the assets under management of passive funds tracking the J.P. Morgan Emerging Markets Bond Index are not very large. Overall, emerging market bond funds appear to be out of favor. There are only a handful of such ETFs with assets in excess of $1 billion. These include the iShares J.P. Morgan U.S. Dollar Emerging Markets Bond ETF (one of the largest emerging markets bond ETFs, with $14 billion in assets), the Vanguard Emerging Markets Government Bond ETF, the VanEck J.P. Morgan Emerging Markets Local Currency Bond ETF, and the SPDR Bloomberg Emerging Markets Local Currency Bond ETF.
Second, global ETFs are free to invest in other securities that do not form part of the index they track.
For example, the iShares JPMorgan USD Emerging Markets Bond ETF and the JPMorgan USD Emerging Markets Sovereign Bond ETF are required to invest only 80% of their assets in the securities that form part of the index. They are free to invest the remaining 20% in other securities. This may also result in under- or over-allocation to Indian G-SEC compared to the index weighting of passive funds.
Signals from the bond market
The reaction in the Indian government bond market also suggested that Wall Street was not too impressed by the move. After the news was announced on September 21, India’s 10-year government bond yield fell slightly. But yields have been strengthening since then.
That’s because foreign investors have been selling off central government bonds over the past five years. FPI holdings in G-Sec fell from Rs 230 crore in March 2018 to Rs 70,589 crore in September 2023. While they used 99% of the 2015 limit, they are currently using only 17%.
The reason for this indifference is that FPI takes a relative view on its bond investments after comparing yields, inflation, currency fluctuations and fiscal conditions of various countries. India’s huge government debt and rising inflation make our government bonds less attractive now, especially as US Treasury yields move higher and US real yields turn positive.
The United States, Luxembourg and Ireland account for the largest share of global debt portfolio investments, meaning the majority of funds flow to the United States and Europe. This is not surprising given rising sovereign bond yields across advanced economies. Emerging market debt may not find many takers until the global economy stabilizes and inflation is brought under control.