Bond market liberalisation — good or bad for India?
Many investors have greeted with enthusiasm India’s plans to get its debt included in international indices such as those run by JPMorgan and Barclays. JPM’s local debt indices, known as the GBI-EM, were tracked by almost $200 billion at the end of 2012. So even very small weightings in such indices will give India a welcome slice of investment from funds tracking them.
At present India has a $30 billion cap on the volume of rupee bonds that foreign institutional investors can buy, a tiny proportion of the market. Barclays analysts calculate that Indian rupee bonds could comprise up to a tenth of various market capitalisation-based local-currency bond indices. That implies potential flows of $20 billion in the first six months after inclusion, they say — equivalent to India’s latest quarterly current account deficit. After that, a $10 billion annual inflow is realistic, according to Barclays. Another bank, Standard Chartered, estimates $20-$40 billion could flow in as a result of index inclusion.
All that is clearly good news, above all for the country’s chronic balance of payments deficit. The investments could ease the high borrowing costs that have put a brake on growth, and kick-start the local corporate bond market, provided more safeguards are put in. Indian banks that have traditionally held a huge amount of government bonds, would at least in theory be pushed into lending more to the real economy.
For decades India has been reluctant to let too many foreigners into its bond markets, fearing currency and interest rate volatility as cash comes and goes. RBS analysts say the caution is justified and the benefits of index inclusion at this point could be outweighed by the costs. They point out that inflation and currency appreciation are often side-effects of such flows:
Frequent episodes of real currency appreciation at India’s present stage of development are far from desirable, as they tend to impede the competitiveness of the manufacturing sector.
Many analysts also argue that what India needs is more direct bricks-and-mortar investment — so called FDI — into manufacturing, rather than the portfolio flows that bond market liberalisation would bring. As no jobs will be created, the flows will not address India’s falling savings rate. RBS again:
There has been a marked deterioration in the savings rate amongst the government, households and corporates. In fact, increases in capital flows have commonly been associated with a stimulation in the propensity of consume for the household sector….we believe that most of the reforms over the last two years have centred on liberalisation of the capital markets and not the real economy. This unbalanced nature of reforms, and almost diametrically opposite to the approach in China, is inappropriate, in our view. Our view has always been to ‘take care of the real economy and the capital markets will sort themselves out’.
Above all, the danger is that a fresh wave of capital inflow from overseas will allow India to further postpone essential but politically difficult measures such as reforming labour laws or easing fuel subsidies. The government, shaken by the summer’s selloff that saw the rupee plunge to record lows, has initiated some reform steps but much more is needed, says Standard Chartered’s Asia economist Kelvin Lau. Lau says opening up bond markets will give India access to a huge pool of cheaper capital but warns:
Opening financial markets should not happen at the expense of structural reform.