Less than 10 days ago, JPMorgan decided to let Indian government bonds feature in their Government Bond Index-Emerging Markets (GBI-EM) index and the index suite. Experts say that solely this inclusion will help India raise billions of dollars in foreign money to fund domestic expansion projects.
But what does a private index have to do with government bonds? And why is this a huge deal for the nation? To answer these questions, we’ll have to start from the very beginning.
What are bonds?
When a government needs money to invest or spend, it has two sources: taxes or debt. Since taxes are, more often than not, inadequate to cover all governmental expenses, the state inevitably has to raise money from the public to finance its operations. This is how bond investing works.
- The government sells ‘bonds’ to investors who are willing to lend money to the government. Bonds are basically contracts that outline an agreement between the government and the ‘investor’.
- This agreement outlines that in return for providing the government with the money it needs in the short-term, investors earn an interest when they get their money back.
You may also like: Gujarat Gas Ltd. (GGL)
What’s the problem?
Now, most of these bond investments come from within the country – from its citizens. And that’s not a very reliable source of capital because investors look out for themselves.
If the private market, for instance, gives them marginally better returns, the government’s debt coffers would run out (theoretically).
The most obvious solution is to attract this capital from abroad – not only will foreign capital be voluminous, but more foreign investments would also free up capital for investments in the private market.
The issue is that the Indian government doesn’t make it very easy for foreign investors to get into the bond game. Since bonds are sold only in INR, investors have to convert their currencies into INR before investing, and more often than not, they end up getting a bad deal on conversion rates.
So they can’t invest ‘freely’.
What’s the big deal with JPMorgan’s Emerging Markets Bond Index?
JPMorgan, a huge financial services firm headquartered in the US, has a basket of international government bonds called the Emerging Markets Bond Index. They use this index to track the returns of governmental bonds issued by emerging economies like India.
For the longest time, India wasn’t featured in this index because of various reasons. Indian bonds, due to several imposed restrictions, didn’t meet the stringent requirements that JPMorgan set out.
By being left out, India was losing out on the money-rich investors doled out on the index.
Now, with several improvements in taxation, limits, and currency interference, the country has made several strides towards getting approved for the index. After several years of working with JPMorgan, the Indian government has finally worked its way into the index.
A few days ago, 23 Indian Government Bonds (IGBs) worth about $330 billion made it to the index. These bonds will start to get listed starting June of next year, until they get to a maximum of 10% of the entire index. Experts think that this could attract more than $20 billion in extra foreign investment to India every year.
But there’s a darker side too
The thing to know about foreign capital is that it’s very agile. Just like the world saw in the Asian Financial Crisis in 1997, foreign money can move out of economies just as easily as it moves in – which puts the Indian economy in a vulnerable position.
While the country can definitely benefit from extra cash from abroad, it also risks the creation of a gaping hole in the government’s coffers if the capital were to exit.
I am passionate about stock investing and have a knack for simplifying complex market concepts. Providing readers with valuable insights and empowering them to make informed investment decisions is my jam.